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Analysis & Opinion
22.07.08 Coming In From The Cold?
By Graham Stack

Many analysts in Minsk see the energy dispute with Moscow at the start of 2007 over subsidized gas prices and customs-free oil exports as marking a break in Belarusian economic strategy. In 2007, Russia put Belarus on a one way track to paying European prices for its gas by 2011, and also ended duty-free oil exports that allowed its small neighbor to earn millions by refining and exporting oil to Europe.

The booming Belarus economy, running at full capacity, with 8 percent annual GDP growth par for the course, was urgently demanding capital investment to stop bursting at the seams. The price rises put a dent in the idea that the state could do it all by itself.

Moreover, the Kremlin actively backed liberalization in Belarus in the hope that Russian capital would move in with vigor.

Having learnt a bitter lesson from the Ukrainian experience under Leonid Kuchma – when Russia subsidized Ukraine with cheap gas, while Russian companies were cut out of the privatization process – Russia has step-by-step shifted to a “non-ideological” approach in dealing with its neighbors.

Newly elected president Dmitry Medvedev confirmed this change on July 15 in his first major speech on foreign policy principles:

"We are fed up with ideological investments. As you know, they were made in the previous period, and it is plain to see how they were paid back. And there should be no clawing at our money, which was inefficiently spent to support corrupt regimes in the future," Medvedev told the Russian diplomatic corps, as quoted by Interfax.

So if bumping up energy prices forced Belarus to open its economy to investors, it was a win-win situation for Russia.

In fact, the new head of the World Bank mission to Belarus as of spring 2008, Martin Raiser, dates the Russia-prompted shift in Belarus policy even further back than January 2007.

"Key aspects of economic policy changed already a few years back. In particular, the unification of the exchange rate and the customs union with Russia meant that key market signals have already been in operation for some time," says Raiser in emailed comments.

“With the rise in energy import prices from Russia, there has been an additional push for greater efficiency and competitiveness,” Raiser explained. “And this has led to a renewed emphasis on private investment and initiative in Belarus. This is new and it is welcomed."

Reform moves

It was in 2007 that the Belarus administration startled analysts by announcing and launching implementation of a draft of reforms aimed at improving the investment climate.

There was and still is a lot to improve on. Pro-private sector measures introduced in 2007 saw Belarus leap up thirteen places on the World Bank's Ease of Doing Business Index – from 123rd place to an only slightly less embarrassing 110th place in the world.

But this is only the start, say analysts. According to the World Bank's Doing Business blog, "in February 2008 the Doing Business team met with forty-five government officials from seventeen different agencies of the Republic of Belarus. Every single one of these representatives expressed their absolute commitment to ease business regulation in the country. Their aim is to be among the top twenty-five countries in the ease of doing business and top ten reformers in the World Bank's Doing Business 2009 report."

In 2007, Belarus also took crucial steps such as acquiring a credit rating, and launching large-scale privatization – with the sale of second largest mobile operator, Velcom, to Telecom Austria, for over 500 million euros.

An indication of the dominant state role in the Belarusian economy until 2007 was that all three mobile phone operators were joint ventures with the state. But in 2008 the state is looking to sell its remaining stakes in operators MTS and BeST. Bank privatization is also on the cards, with Germany's Commerzbank looking set to acquire fifth largest Belinvestbank. Austria's Raiffeisen International already owns the country's third largest bank, Prior Bank.

This burst of reform activity in 2008 has caught many observers by surprise. Many expected the reform drive to be slow. However, as energy prices in 2008 have shifted back in Belarus' favor, the country looks likely to run in a record trade surplus instead of the feared deficit this year. But according to Dmitry Kruk of Minsk's Institute of Privatization and Management, the government has redoubled its liberalization efforts this year, indicating that “a strategic decision” has been taken by the president.

Key challenges

World Bank's Martin Raiser sees three key challenges facing the government.

"Belarus in some sense benefits from the fact that several of its key industrial assets are relatively new (built in the late 1980s) and that government-led efforts have achieved some success in modernizing the flagship companies," Raiser said. "But a lot of inefficient, often state-owned enterprises still exist in smaller towns which will need to attract private strategic investment if they are to survive."

"Secondly, Belarus needs to make better use of its key assets – an educated labor force and a strategic location as a bridge between Russia and Western Europe. For this, it needs to encourage innovation and entrepreneurship to complement the high human capital, while it must also reorient trade and transport links towards Europe and make it easier and cheaper to transit across its territory," Raiser continued. "Thirdly, Belarus will need to cope with a deteriorating demographic position and the implications this has for the social inclusiveness of future economic growth. As the labor force declines due to an aging populace and migration, the financing of generous social transfers through high levels of payroll taxes will come under pressure and the need to improve targeting of social assistance for the most vulnerable and to encourage greater labor force participation will become ever more pressing."

The question facing Belarus is whether the top-down approach pursued by the government is sufficient to master these challenges. Raiser notes that, while the government has "the ambition to tackle these challenges broadly," the authorities "are aiming at efficiency improvements rather than wholehearted institutional change."

Between Europe and a hard place

Nevertheless, the logic of reform in Belarus might yet kick-start some political liberalization to make the country more acceptable in the eyes of the West.

If economic reform in Belarus was initially prompted by relations with Russia shifting to market principles, then reforms now seem to target West European investors, according to Viktar Strachuk of Deloitte, precisely to avoid Russian capital predominating in the country.

The government wants Western investors to counterbalance Russian influence. But Western investors are still wary of Belarus, because of the stigma attached to “Europe's last dictatorship.” So, ultimately, economic reform will require some degree of political liberalization at least in the form of some masquerade. Lukashenko seems to have recognized himself that image is important: in early 2008, he hired famous British spin doctor Lord Tim Bell, who previously worked for General Pinochet, Boris Berezovsky and the British Conservative Party.

Lukashenko has even promised that the upcoming parliamentary elections in September 2008 will be a “model of democracy.” The claim has met with understandable skepticism from opponents. However, there is considerable room for Lukashenko to liberalize and allow opposition, without losing his iron grip on power, since he enjoys Putinesque levels of popularity, as the economy surges ahead.

On the other hand, such a move would require Belarus' “Bat’ka” to at least allow public questioning of his infallibility – and there has been little sign that he is psychologically ready for this.
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