Interview of Pavel Kallaur, Chairman of the Board of the National Bank of the Republic of Belarus, to the newspaper "Respublika"

Money Likes Stability

Governor of the National Bank Pavel Kallaur tells about inflation expectations, problems and developments in the banking sector and dedollarization of the economy

Surely, money does not rule the world. Yet, it is the backbone of the modern economy, no matter how much we want to think otherwise. That said, macroeconomic stability largely depends on a balanced monetary policy of the government. Over the past three years, the country’s financial system has undergone significant changes. We managed not only to ‘get rid’ of the fixed exchange rate, but also to ensure exchange rate stability. Inflation rate is holding at its record low. The deposit market saw a revolution that resulted in the introduction of irrevocable deposits with no excessive fuss. The policy rate is constantly decreasing and is approaching a one-digit number. Even traditionally skeptical and conservative international experts do not throw doubts on Belarus’ success in achieving stability. However, many positive changes are yet to come. Chairman of the Board of the National Bank Pavel KALLAUR shared his views on the monetary policy objectives and instruments to achieve them.

Inflation Fully Controlled

– Mr. Kallaur, in June 2017, a presidential decree specified the National Bank’s main objectives. Now the main goal of the monetary policy is not ‘protection and stability of the Belarusian ruble’, but price stability. Why did the National Bank become responsible for inflation rates in our country? And how are you going to achieve price stability?

– The objective of any public administration agency is to enhance the welfare of the society. The National Bank contributes to the common cause by ensuring price stability. It does not mean that prices should stay unchanged, but they should increase in such a manner so that to ensure persistently low inflation rates. The choice of this main objective for the central bank can be explained by the monetary nature of inflation. In the long run, money supply completely transforms into price growth. This postulate repeatedly proved both in theory and in reality. Therefore, it is a global trend to entrust the function of ensuring price stability to central banks who curb the inflation pressure through managing the volume of printed money and the value of money in the economy.

To achieve low inflation rates, the National Bank uses a system of monetary policy tools, the main of them being the policy rate. The National Bank Board takes decisions on the policy rate level as well as on other monetary parameters. Our decisions are based on the macroeconomic forecast. If pro-inflationary risks reduce, the monetary policy can be loosened and the policy rate – brought down, and in reverse. The National Bank takes all measures in a transparent and open manner. This is utterly important for strengthening the trust of market participants who adjust their behavior in accordance with the regulator’s messages as well as inflation and macroeconomic forecasts: they can boost economic activities, increase borrowings or, oppositely, limit lending. Such interaction between the National Bank and economic entities is conducive to bringing the price movements as close to the target as possible.

– Consumer price index is at its historic low. However, both households and CEOs have quite high inflation expectations. Such attitude put pressure on the real inflation indicators and do not stimulate financial stability. What can be done to change people’s feelings and encourage reasonable optimism?

– Managing inflation expectations is one of the most difficult processes in economics. By the way, in many countries people’s expectations used to be and still are higher than actual price growth. This is a natural human reaction to the past shocks and uncertainty about the future that always exists. The question is how much expectations differ from actual indicators. In Belarus, this difference is quite big so far. How can it be reduced? A principal thing is to restore credibility of the economic policy and projected indicators. The National Bank should be the main newsmaker in this respect. If it declares a target for a certain CPI indicator, this target should be achieved. Minor deviations from medium-term inflation targets are acceptable but the reason for that should be clearly explained. If the public gets an opinion that inflation will be exactly as stated, then the expectations will not be negative.

Inflationary expectations should be regulated jointly – this is another issue. Other agencies are obliged to help the National Bank. There is a psychological effect when people form their opinions about the overall price growth based just on one or several groups of fundamentally important goods. Presently, in cooperation with the MART, we are developing mechanisms to mitigate price shocks for individual groups of goods. Ideally, increases in state-controlled prices – for housing and utility services, transport, communications and others – should not exceed the planned core inflation.

Public communications policy has a great influence on expectations. It should be understandable and transparent, so that the National Bank becomes the central figure in inflation-related communications while its messages are clearly and comprehensibly formulated in order to influence economic entities’ behavior in terms of pricing policy. This is one of the conditions for transiting to inflation targeting, when even verbal statements and signals from the central bank affect the market condition.

On External Assessments

– Recently, FitchRating confirmed the country’s long-term rating at ‘B’ with a stable outlook. At the same time, experts believe that the core problems are related to a high public debt, dependence on the exchange rate fluctuations and a weak banking sector. Undoubtedly, any expert evaluation is subjective to some degree, and its result largely depends on the methodology used. Nevertheless, how stable is our financial system in general and the banking sector in particular?

– Undoubtedly, FitchRating is a reputable international rating agency with a team of highly qualified experts. It is logical to listen to their opinion. However, we must understand that international experts usually prefer to give conservative assessments. Yet, we can agree with many of their judgments. In addition, experts highlight many positive trends that are strategically more important than the problems mentioned. For example, FitchRating notes high structural indicators of the Belarusian economy, in particular, GDP per capita and human development that are better than in many peer countries. These are important achievements of our sovereign country, which is something to be proud of.

As to the financial sphere, FitchRating points to relatively strong public finance that is able to ensure flexibility of short-term funding. The agency also believes that Belarus will be able to keep inflation rates below 6 percent this year. They also note the consistency of the implemented policy and improvements of the monetary regulation transmission channels due to further progress in reducing dedollarization and quasi-fiscal lending under government programs.

However, there are some problems, according to FitchRating. Public debt totals 37 percent of GDP and exerts considerable pressure on fiscal policy. More than 90 percent of the debt is in foreign currency. Therefore, the economy remains quite dependent on exchange rate fluctuations. In case of the Belarusian ruble depreciation and related revaluation of the national debt, there are indirect risks related to the widespread practice of issuing state guarantees on loans and the existing ownership structure. Many major state-owned enterprises have weak financial indicators and bear a high debt burden, mostly in foreign exchange. Therefore, the exchange rate volatility creates additional financial risks for such companies and fiscal risks for the state because of the potential need to inject additional capital into distressed assets, execute guarantees on loans and issue debt securities in exchange for loan debts. While 7-10 years ago currency depreciation, with all its negative side effects, was able to smoothen macroeconomic imbalances, increase competitiveness of the real sector goods and services and reduce imports, with the present level of dollarization of the economy and considerable credit burden, the weakening of the ruble only worsens the real sector and public finance condition.

Meanwhile, the thesis about the weakness of the banking sector is very controversial. Indeed, problems of state-owned enterprises do have implications on Belarusian banks due to a relatively high share of non-performing loans. However, qualitative indicators of bank loan portfolios have stabilized over the past year. The required reserves have been provisioned in full, banks have a good level of capitalization and, in principle, have already adapted to the conditions of a highly volatile operating environment and work stably. Some risks always exist. Of course, it is possible to minimize the probability of the financial system destabilizing using various restrictions. However, such stability might undermine economic and financial efficiency.

We should learn how to competently manage risks rather than trying to completely avoid them. Key financial stability indicators that are in the focus of the National Bank attention, are within safe ranges. The banks meet all capital adequacy and liquidity requirements in accordance with the up-to-date Basel III international standards. The results of the recent stress-testing of the banking sector also indicate stability of the financial system in respect of major risks.

A number of serious issues stemming from past crises have been resolved since 2014. Probably, the most important achievement is people’s credibility towards the banking system. Even with a slowdown in the economic growth, the reduction in household foreign exchange term deposits proved commensurate with the decrease in real disposable income, while term ruble deposits even increased by 23 percent over the past three and a half years. During the same period, interest rates on the credit market significantly decreased, which improves investment opportunities for Belarusian enterprises. In June, the average rate on new national currency loans to legal entities was 11.28 percent per annum. According to our estimates, currently the monetary conditions, including interest rates in the loan and deposit markets, are generally neutral. We will take efforts to preserve this neutrality in the short term. At this stage, the priorities of the financial system development include its qualitative transformation, solving accumulated problems, strengthening and structural reorganization, wide introduction of modern technologies that form preconditions for further growth. The main directions of the financial market development include further assistance in non-performing loans resolution (including the creation of an effective debt market, improving the Asset Management Agency operation), enhancement of regulation and supervision in all segments of the financial market based on the principle of proportional regulation and promotion of competitiveness.

Foreign Exchange Issues

– In 2015, the country voluntarily cancelled the fixed exchange rate regime. However, many CEOs would like to return it – at least, this is what various surveys, including those conducted by the National Bank, show.

– There is certain advantages in linking the ruble to one of the world’s strongest currencies. Depreciation and, hence, inflationary expectations are declining, and macroeconomic stability is achieved. However, the National Bank then faces a difficult choice of determining a fair exchange rate. The thing is that each market participant has its specific interest: for exporters it is more profitable to have the weak ruble, importers prefer the strong national currency, for some it is optimal when the ruble is pegged to the dollar, for others – to the euro or the Russian currency. Having a fixed rate requires a balanced development and strict observance of the macroeconomic, monetary and fiscal policies. The most problematic thing is that our economy is open, and thus is prone to influence of numerous external factors. When the exchange rate is unchanged, various imbalances inevitably accumulate that only can be removed through depreciation. Depreciation does not bring much benefit to the economy, especially when international markets face permanent volatility. There was no doubt about the need to move to a floating exchange rate. At least, external shocks are absorbed due to exchange rate fluctuations. Depreciation risks do not accumulate, the economy develops in a balanced manner, and exporters enjoy favorable conditions. The past years’ results have proven that our stance is correct. The foreign exchange market, financial system and banking sector are stable, and the exchange rate risks for the economy are at an acceptable level.

– Western companies have long learned to minimize the consequences of changes in foreign exchange markets hedging their risks (insuring those by making transactions in the futures market). Do our enterprises use these tools?

– The legal framework for hedging foreign exchange risks is in place. Transactions with derivatives can be carried out both on the exchange and over-the-counter markets. We work in close contact with the Ministry of Finance to improve the legal and regulatory framework for hedging instruments accounting and taxation of revenues. We need to move more robustly along this path. The whole world does that. Unfortunately, Belarusian companies do not hedge their risks as actively as we would like them to. There is no such culture, and enterprises lack personnel with relevant skills. Therefore, not all large exporters, unlike banks, manage their foreign exchange position. They simply keep money on accounts, selling foreign currency as needed and often lose additional benefits. I would emphasize a positive trend though: recently, banks have stepped up transactions with derivative financial instruments. For instance, last year the volume of such transactions reached 1.6 billion rubles increasing fivefold compared to 2016.

– Apparently, the process will go faster when the economy dedollarization plans are implemented. How far have you advanced in this direction?

– The country’s losses from dollarization are significant and mostly relate to exchange rate and inflation risks. Dollarization makes it difficult to apply efficient monetary policy tools. The share of the national currency in the broad money totals only 38 percent. Therefore, the transmission mechanism works with serious distortions. In the past years, the National Bank jointly with the Government have been consistently implementing measures to phase out the use of foreign currency in the country. The latest innovations include amendments to the Tax Code that abolish the option of paying almost any tax in foreign exchange. Another important step is work on amendments to the Civil Code assuming that foreign exchange liabilities only will be possible when settlements in foreign exchange are legally allowed. It is also proposed to establish an exhaustive short list of cases of using foreign exchange in internal settlements, and cancel the licensing procedure for such transactions for individual economic entities. It is necessary to completely abandon individual preferences in the area of foreign exchange legislation. It has been reconciled with the Ministry of Finance that domestic issuance of bonds denominated in foreign currency should be limited for all corporate sector entities including banks. The Government has supported this approach. Undoubtedly, dedollarization should be coupled with liberalization of the foreign exchange legislation. A number of relevant measures were taken including cancelling the use of passports of individuals for foreign currency purchase and sale transactions with banks, cancellation of targeted foreign exchange purchases, and foreign exchange surrenders among others. Implementation of comprehensive and consistent measures in both directions should give a synergetic effect. But, of course, much depends on psychology and the long-term habit to measure everything in ‘conventional units’. Previously, with high inflation, using dollars for settlements was somehow justified. However, after the national currency stabilized, it is necessary to use Belarusian rubles for all settlements and contractual relations. At the end of the day, this is an important factor for stability of the financial system and economy as a whole.

Respublika newspaper, August 3, 2018