OREANDA-NEWS. October 5, 2011. Standard & Poor's Ratings Services today lowered its sovereign credit ratings on Belarus to 'B-/C' from 'B/B'. The ratings were removed from CreditWatch, where they were placed with negative implications on May 27, 2011. The outlook is negative. The transfer & convertibility (T&C) assessment for Belarus has been changed to 'B-'.

The recovery rating on Belarus' senior unsecured debt is unchanged at '4'. This indicates the expectation of a 30%-50% recovery in the event of a default on Belarus' commercial debt. The estimate draws on a scenario - not a base case - of severely negative external financing trends that economic policies cannot offset.

The downgrade reflects concerns over Belarus' ongoing dependence on external funding due to large current account deficits and a very low level of usable reserves. “We remain highly uncertain as to Belarus' ability to secure such funding, and we believe the government has made only limited efforts so far to remedy the underlying causes of the external imbalances. This has put significant pressure on the official exchange rate (which we consider overvalued) and has added to economic stress in Belarus. Additionally, following the exchange rate movements this year, the predominantly foreign-currency-denominated government debt burden has increased significantly as a percentage of GDP. We forecast it will almost double to above 40% of GDP by year-end 2011 (excluding guaranteed debt)”, Standard & Poor's said.

The ratings on Belarus are constrained by political risks and external, monetary, and fiscal imbalances arising from expansionary fiscal and monetary policies aimed at supporting domestic demand. The ratings are supported by the country's relatively high GDP per capita for the rating level, its substantial industrial capital stock, and its highly educated workforce. These factors provide the potential for a quick recovery, should the government rein in macroeconomic imbalances and pursue microeconomic reforms, supporting private-sector growth.

“We expect the current account deficit, which rose to over 15% of GDP last year and moved the central bank to a net foreign liability position, to contract to just over 10% in 2011 and then to single digits in 2012. The government's external debt repayment schedule appears fairly light for the remainder of the year, but is higher in subsequent years,” Standard & Poor's said.

In its base-case scenario, to fund these external outflows in 2011 Belarus will rely primarily on loans from the Eurasian Economic Community (EurAsEC) and Azerbaijan, as well as privatization receipts - most likely from natural gas infrastructure and transportation company, Beltransgaz, which Standard & Poor's expects will be sold in the coming months. A further loan of about USD 1 billion could come from Russia-based bank, Sberbank, via potash producer Belaruskali, and a similar-sized loan from China. Cross-border bank borrowings may also finance part of the current account deficit. In its base case Standard & Poor's are assuming no funding in 2011 from the IMF, as it appears there is not enough agreement on the optimal policy mix in the current environment.

In 2012 there could be another two tranches from the Eurasian Economic Community Anti Crisis Fund as well as further privatization receipts. A partial sale of Belaruskali is feasible next year along with smaller privatizations and privatization income from the sale of Beltransgaz.

On the reform front, Belarus has taken several actions to address its ongoing economic crisis. The central bank has increased interest rates, though these remain negative in real terms. Government-supported lending programs that fuelled credit growth are being scaled back dramatically. On the fiscal side, we expect tightening and a deficit under 1% of GDP, but off-budget spending and a weakening currency will typically result in much higher increases in debt. Also, possible financial-sector recapitalization costs could arise if the economic situation does not stabilize. While these measures help reduce the imbalances, they fail to address the underlying causes of Belarus' external imbalances in particular. There has been little notable progress in liberalizing the economy, privatization is proceeding very slowly, and the private sector remains underdeveloped.

S&P’s local-currency rating is equalized with the foreign-currency rating because monetary policy options, which underpin a sovereign's greater flexibility in its own currency, are constrained by Belarus' high inflation and less-developed bond markets. S&P’s T&C assessment is the same as the sovereign foreign-currency rating, reflecting their view that the likelihood of the sovereign restricting access to foreign exchange needed by Belarus-based nonsovereign issuers for debt service is similar to the likelihood of the sovereign defaulting on its foreign currency obligations. With increased external vulnerabilities, the government has earlier this year introduced some foreign exchange restrictions including a ban on restrictions on advance import payments and a foreign exchange transaction tax.

The negative outlook reflects the likelihood of a downgrade if prospective external funding does not materialize, or is insufficient in the face of further downward exchange rate pressure and economic stress, particularly a significant decline in bank deposits.

Success in bolstering net international reserves, which would likely entail reforms to strengthen external competitiveness, could support the ratings at their current level. A policy mix that relieves inflationary pressures, reduces the current account deficit, and starts to stabilize the economy would be consistent with an upgrade.