Belarus Business outlook Quarterly update - April 2013 by Daniel Thorniley and Katy Shields

Contents Executive summary Key facts Business outlook Features of business Economic outlook Inflation outlook Currency outlook Forecast table

Executive summary (1) Belarus survived 2012 with some noticeable GDP slowdown The final quarter was very harsh similar to global trends but there were also specific local reasons as well (see below) In general crisis period of was not more brutal thanks to 1) Russian energy subsidies 2) high prices for re-exports of energy 3) loans from the Russia- dominated Eurasian Economic Community and 4) tighter monetary/fiscal policy The economy is starting to look more “twin-track” with consumer-related sectors performing better than industry and investment Last year a slump in investment and slower exports were the main reasons behind the GDP slowdown But business results were salvaged thanks to booming credit propping up state enterprises but not local private enterprises where credits were actually negative Consumer credit though was very strong

Executive summary (2) Real wages after inflation are among the very highest in the world This looks unsustainable and with some budget tightening and a slowdown in industry, we expect a slower level of household spending and weaker retail sales this year Wages are also among the most volatile in the world and this makes business planning for FMCG and food & beverages companies challenging Consumer products companies should be looking to a slower year or a moderate one in 2013 Inflation fell to 20% at year-end 2012, with an average last year of 60% We see inflation at 18% average this year The currency was stable through 2012 but weakened by 8% in the last five months to 8,600 to the US dollar

Executive summary (3) Belarus remains a “funny/peculiar” market, but a growing number of companies are looking at market entry After dallying with EU in , Belarus and Lukashenko look to be settled firmly in bed with Russia and dependent on Russian economic and financial support Sharp wages increases prior to the December 2010 elections (spurring imports and FX demand) were a root cause behind the 2011 financial collapse Wages/credits ballooned again in 2012 and a bubble element could be building up Executives and finance directors should plan to ride happily any economic wave but watch out for the popping bubble! and manage receivables Good news is that, at least according to official figures, the government is controlling spending to prevent any credit or currency crash Leadership’s aim is for a balanced budget this year but also wants a mild stimulus and thus we see a budget deficit of -1.0% this year If this juggling works out, then these numbers are acceptable

Key facts Population of 9.5m, officially declining by around 0.3% per year, but possibly more Europe’s “last dictatorship”, run by President Aleksander Lukashenko since 1994 The president controls all arms of government and the media, and opposition parties have been largely silenced, arrested or have simply left Since 2010, part of a customs union with Russia and Kazakhstan Belarussians can also work and study in Russia without the need of a visa Net importer of gas from Russia (currently at a 40% reduced fee) Main exports are machinery and transportation equipment (especially tractors) The state controls 70-80% of the economy with a similar share of employment – many of its state-owned enterprises are unproductive and in need of investment Unemployment is officially 0.6% but unofficially it is probably much higher as people refuse to take low-paid jobs with inflation running so high A recent Gallup poll estimated unemployment at 24%! Fears of a “brain-drain” as high inflation in recent years has seen cost of living shoot up with many leaving for Russia

Business outlook (1) Belarus ranks No7 for companies last year (2012) and this year It is one of several small CIS markets (including the three Caucasus markets) along with the bigger ones of Russia and Kazakhstan which, together with Turkey, are considered the best sales options at the moment Top-line sales growth may be comparatively encouraging, but the volume is small 2012 may have turned out a bit better than anticipated for some companies given the elements of bubble economy such as consumption Sales may moderate this year given the expected GDP slowdown For average manufacturing companies (excluding the energy sector) a long standing rule of thumb is “The Rule” for volume sales in CIS By this we mean that 85% of sales take place in Russia, 10% in Ukraine and 5% in the rest of the CIS, with Kazakhstan being the third largest market Thus Belarus can only be accounting for 1% or at most 2% of CIS business for most manufacturing companies

Business outlook (2) There may be some discrepancies if companies create strong niche in the market By the same token some big FMCG companies sell a larger proportion in Ukraine But there is some sales growth in Belarus and more companies are “taking a look” as sales slow across Europe The scope of sales forecasts for this year do not vary much from 2012, but are slightly more upbeat This year no company predicts negative sales (compared with almost 10% last year) while some 20% are budgeting for flat sales About 55% of western executives predict single-digit sales growth with a spread across low-single and high-single digits This leaves about 25% of firms forecasting double-digit sales growth this year But given the predicted economic slow down this year, business may not be quite so strong in terms of GDP support

Latest sales and profit projections

2012 sales and profit results by sector

2013 sales and profit projections by sector

Business outlook (3) – consumer products Consumer products companies had a better year in 2012 than 2011 but results were mixed across sub-categories and even within same categories but perhaps more often on the upside thanks to the credit boom But the level of bank credits does not always impact positively on FMCG and food & beverages sales as people do not take out bank loans to buy a bar of chocolate! One major US food & beverages company reported last month by phone from Minsk: “We saw sales fall in late 2011 by -15% and the recovery was slow. Consumers downtraded and bought less frequently. We had to innovate downwards and go for offers and discounts and it was tough. But by summer 2012 we started to chart a better pick-up and that stayed with us for the rest of the year. That said, I have noticed some renewed slowdown at the start of 2013.” But another US FMCG company spoke for many when he said recently: “The crisis ought to have been much worse in some ways, based on economic figures in 2010 and 2011 but actually it turned out not too bad. A short, sharp shock and then a good quick recovery.”

Business outlook (4) – consumer products and food/beverages Another US executive commented to me recently a good piece of common sense: “As you know Danny, this is a “funny” economy” and there are many hidden subsidies and strange cross border activities. The downturn ought to have turned out differently. So we should be happy? Yes, but maybe a bubble is blowing up?” Belarus ranks No 10 among the 23 markets we survey regarding consumer good sales this year Good news is that no CP company surveyed foresees flat or negative sales in 2013 But most companies (80%) are clustered in single-digit figures while one fifth are hoping for a low double-digit sales expansion So companies are being cautious and have already witnessed the end of any bounce-back from the crash Food & beverages forecasts for this year are more mixed with 20% budgeting flat growth, almost 40% seeing single digits but fully 37% forecasting double-digit sales This upside is probably due to food & beverages entering the crisis early and deep We are now seeing the eventual recovery in this sub-sector

Business outlook (5) – industrial B2B Thanks to reasonable credit levels, government subsidies and with Belarus enterprises able to generate FX revenue, the industrial B2B sector is not expecting to be devastated this year Just 18% of companies predict flat growth and no firm foresees negative growth in what is regionally a very weak business sector Two-thirds of western players forecast growth in single digits and these are spread evenly across low single digits and high single digits And more than 15% in this sector are budgeting for moderate double-digit sales increases this year For comparison: in this sector in the Czech Republic 50% expect flat or negative sales and 40% low single-digit sales

Business outlook (6) – industrial B2B/IT The country manager of one major European industrial conglomerate explains his business thus: “We grew sales in 2011 by 10% and these rose by 13% last year but we did notice slowdown from about September. But I don’t expect any collapse this year. The macro numbers may turn against us but our Belarus industrial clients get money from the government or from the banks at reasonable interest rates and some of them export to Russia at decent prices. So this makes the market a bit different and better than some others in CEE.” Another executive noted that: “Financing is not yet much of a problem” As in other CEE/CIS markets the IT sector seems set for a knock this year Almost two-thirds of such companies predict no growth and the rest look to moderate single digits Once again this is probably due to this industry’s “crisis cycle” Many IT companies survived the initial stages of the crisis relatively well compared with others sectors But after three years or more of crisis impact is finally coming to the IT industry

Business outlook (7) – healthcare and pharmaceuticals The other sector which has survived well relatively is pharmaceuticals and health This sector is not going the way of the IT industry but may see a mild slowdown if the government tightens spending, but that is an open question 20% of firms in this sector predict flat growth and 50% are budgeting for single- digit growth, but with the majority of these aiming for growth in high single digits Another 20% forecast moderate double-digit sales increases So for pharmaceuticals, not a block-buster market but very much “not bad”

Features of business Due to its market size Belarus does not rank as a priority market But more western companies are assessing the market to find “a pocket of growth” while other CEE markets struggle This is reflected in the fact that 16% of firms are looking at changing their route to market, which ranks the country as No 4 in the region on this criterion Hardly any companies are considering reducing headcount or cutting costs in sales and marketing because this is a small, potential growth market Downtrading affects 20% of all companies surveyed, but as many as 60% in the FMCG sector Receivables are an issue for 15% of all firms but this shoots up to 50% of consumer products firms

Economic outlook (1) – GDP and growth drivers GDP growth slowed to 1.5% last year, from 5.5% in 2011 The 2012 GDP figure is slightly worse than we previously forecast and is owing to a very weak and slightly unusual Q4 After growing by around 3.0% in the first three quarters of 2012, output fell by -1.9% in the last quarter of 2012 As we warned in our last update, the economy took a hit partly owing to weaker European growth but also following the reversal of a dodgy re-export scheme to Russia (Belarus had been mis-labelling oil products to avoid Russian levies) Exports had been growing in double digits at the start of last year but slowed to 3.5% yoy in Q3 and fell by an estimated -15% yoy in Q4 However part of this is a one-off fall and exports already “bounced” somewhat in December and the start of 2013 Overall export growth was about 10% last year vs import growth of less than 2% (the trade balance was about zero)

Economic outlook (2) - GDP and growth drivers Industrial output grew by just under 6% last year, from 9% in 2011 Part of the growth in industrial output came from the re-export scheme in the earlier part of the year, with output tailing off towards the end of 2012 With slowing export and industrial numbers, growth was led mainly by strong consumer spending figures, with retail sales zooming by over 14%, credit growth of 35% and household spending around 8% Full-year household spending figures for 2012 are not yet available, but spending was growing by 6% in the year to September and we expect this increased in Q4 as the impact of strong real wage increases filtered through (see more later on this) This is also underscored by our Survey which indicates that B2C companies had a better year by the end of 2012 than they expected mid-way through the year High growth in new bank credits and wages could prove dangerous, but the good news is that the rate of credit growth continues to abate, along with volumes of bad debts

Economic outlook (3) - GDP and growth drivers Government spending (and see next slides on budget) was slightly negative last year, due to some tightening to curb debt and inflation The biggest hit to GDP and overall confidence last year came from a deep slump in fixed investment, which collapsed by -10% This is better than previous estimates but still very weak even by regional standards, and reflects continued uncertainty about growth and currency stability We see only moderate investment recovery this year at growth of around 2% Exports could come under pressure this year after the “funny” 2012 The consensus is for weak EU growth and given the high base of much of 2012 this indicates that exports could be lower this year, despite a weaker currency, owing to terms of trade This would contribute to the deteriorating outlook for current-account deficit. Belarus runs a healthy surplus with the EU (about 40% of exports) as it can sell heavy-industry products at competitive prices thanks to internal subsides

Economic outlook (4) - GDP and growth outlook On the other hand trade with the Custom Union (also about 40% of exports) remains heavily in deficit owing mainly to (subsidised) Russian oil imports Belarus continues to receive gas from Russia at $168 per thousand cubic metres while Ukraine pays about $400 Belarus plans to use its stewardship of the CIS presidency this year to push for greater trade integration in areas like high-tech and green technologies But it will be a long time before the trade pattern shifts and in the meantime the country’s trade structure will remain a “pack of cards”, held up by Russia Industrial output has been flat in the first two months of this year (partly owing to the high base of early 2012) and we expect it to stabilise at about 4% average in 2013, thanks to government subsidies and financial support Industrial production should continue to grow moderately in subsequent years, which is probably “not bad”

Economic outlook (5) – consumer spending Overall we continue to expect a moderate recovery of GDP of just below 3% this year, supported by domestic demand and continued government subsidies and with Russian growth of around 3.7% Risks are on the downside though and include weaker than expected Russian or EU growth, another inflationary spike eroding real incomes and spending, as well as any change in Russian support in the way of loans or energy subsidies

Economic outlook (6) – budget balance After tightening fiscal policy in 2011 to reach a surplus of +2.4%, the government eased off on the fiscal side last year, reversing several privatisations, increasing wages and maintaining a variety of subsidies Officially, it managed to keep the balance just positive at 0.5%, with spending falling by -1.0%, but this excludes some quasi fiscal activities such as state supported lending, subsides and bank recapitalisations The government is aiming for a balanced budget this year but we forecast a small (official) deficit of -1.0% as the government will continue to provide financial support to consumers, banks and industries while aiming to pare down debt Following the 2011 devaluation, external debt ballooned to over 70% of GDP In order to pay off rising debt redemptions in ($3.1m of debt matures this year), Belarus will sell off further assets to Russia: the latest loan agreement earmarks $5bn of privatisations Though IMF recently said it wants more aggressive fiscal policy to ensure stability (removing price controls/subsidies, etc), there are few signs this will transpire

Economic outlook (7) – bank credits Credit expansion has been a key driver and support to the economy While new bank credits have been growing across Europe at 0-2%, in 2011 new loans were rising in Belarus at 50-60% Credit growth was 34% last year as authorities imposed tougher credit terms Almost half of all lending went to prop up public enterprises, to which credit more than doubled during 2012, while lending to private companies actually fell overall, though it began rising in the second half of the year (by 15% from July onwards) Consumer lending was sluggish initially but also picked up in H2 and averaged 21% growth for the year following rises in real wages as inflation softened Central bank continues to lower its reference rate (latest cut to 28.5% in March) along with falling inflationary pressures as the impact of the devaluation filters through, though with inflation no longer falling there will be fewer cuts this year The good news is that bank deposits are still rising healthily but for some western companies this means that consumers are saving and not spending

Economic outlook (8) – consumer spending Wages and retail sales increases were some of the highest in the world last year After very solid retail sales (up 14%) and household consumption growing by at least 8% in 2012, we predict a retail slowdown to 4.0% this year, with household spending growing slower at 4.7% We think these estimates are appropriate given credit, inflation and wage trends This will depend on external and government subsidies and support programs, which affect nominal wages and savings levels Because inflation spiked up in 2011 and 2012, real wages after inflation have been on a rollercoaster: they leapt by 15% in 2010 but then slowed to just 3% in 2011 (In comparison western European real wage growth is usually zero or negative and growth in CEE 1-3% at best, and in Russia 5-7%) The dynamics in real wages remain up and down: they rose about 22% in 2012 but were actually negative -2.5% in first quarter of year but up around +25.0% in second half of year (in-line with falling inflation); they jumped 23% in January 2013

Economic outlook (9) – consumer spending But some of this is owing to base effects and we see wage and income growth softening over the year owing to lower external demand, moderately lower government spending and continued moderate/high inflation Retail sales growth have not followed the pattern of wages and were steady and very strong at about 12-14% through last year, and rose 22% in January 2013 Retail sales should return to more normal, yet still strong, levels of 4.5% to 5.5% in next 1-2 years Not all retail sales are going to western brands As in other CIS markets, lower income consumer segments are spending more on cheaper products and in open markets and kiosks This probably means citizens still have good savings levels (deposits are still rising strongly and grew 53% last year) and so when wages wobble, they dip into savings Consumers also seem to be saving up “for a rainy day” given economic volatility of recent years and much (about 70%) of deposits are in FX, although bank loans in FX have been curtailed

Inflation outlook Inflation was on a downward trend in the final months of 2012 as the economy slowed Year-end inflation finished December 2012 at 22%, while the average inflation rate last year was almost 60% We foresee inflation falling (in line with the consensus) to average 18% this year (it was around 23% in January and again in February) Inflation will slow further a bit in 2014 to 16% but stay stubborn at about 10-12% in With possible further currency depreciation and limited fiscal consolidation this year there may be more negative risks on the inflation front in But presuming a currency collapse is avoided, then we should not see any return to hyper- inflation As in other markets, inflation has been driven by food prices High levels of banks credit and wage levels could entail higher inflation and too-abrupt removal of subsidies would have the same effect – so some further upward risk Also any energy price hike by Russia would have a knock-on effect on prices The National Bank responded to hyper-inflation in 2011 with interest rates of 60% and extended price controls, but rates have now fallen to 28.5% (mid-March 2013) The Bank’s goal will be to keep interest rates positive in real terms and with inflation down to about 23% this is being achieved

Currency outlook In 2012 the National Bank shifted its focus from currency support to inflation targeting However, the currency remained stable for most of 2012 and hit its strongest level just below 8,000 to the US dollar in spring 2012 But from September, probably due to a reversal of an energy re-export scheme at Russian bequest, the currency started to fall, and has hovered around 8,600 – 8,650 to the dollar since the start of the year (though as the Euro has weakened to the dollar it was around 11,150 in March from 11,630 earlier this year) Given the quirky nature of the economy, hidden subsidies and Russian energy support, it is tricky to predict the rate of possible depreciation The currency can always slump sharply if Russian support is removed The government’s proclaimed goal of 8% GDP growth this year is a non-starter but if it is seriously pursued, then a bubble threat could cause another currency collapse Our mid-case scenario is for rouble to fall to average of 9,000 in 2013 after an average of 8,300 last year with average depreciations of 4-6% annually in subsequent years We add the proviso, as ever, on downward risk and corporate finance directors are already aware of this!

Belarus - economic outlook: statistics GDP Fixed investment Industrial output Household spending Government spending Real wages Retail sales Consumer prices (average) Budget balance (% GDP) Current account (% GDP) Exports Imports Rouble/euro (average) 6,56710,76211,70012,20013,00013,50013,000 Rouble/dollar (average) 4,9758,3369,0009,4009,90010,30010,700 Note: Real annual % change unless stated

© 2013 CEEMEA Business Group* *a joint venture between DT-Global Business Consulting GmbH, Address: Keinergasse 8/33, 1030 Vienna, Austria, Company registration: FN t and GSA Global Success Advisors GmbH, Hoffeldstraße 5, 2522 Oberwaltersdorf, Austria Company registration: FN k Source: DT-Global Business Consulting GmbH and CEEMEA Business Group research Basic data sources come from central banks, own intelligence network, CEEMEA Business Group corporate survey, governments and other public sources. Interpretation, views, forecasts, business quotes and business outlooks by DT- Global Business Consulting GmbH and CEEMEA Business Group. This material is provided for information purposes only. It is not a recommendation or advice of any investment or commercial activity whatsoever. The CEEMEA Business Group accepts no liability for any commercial losses incurred by any party acting on information in these materials. Contact: Dr Daniel Thorniley, President, DT-Global Business Consulting GmbH M: / E: / W: