I. Overview

1. Economic growth has been decelerating in Belarus. Despite the positive impact of Russia’s strong recovery from the 1998 crisis, real GDP growth dropped from 8½ percent in 1998 to an estimated 3 percent in 2001. This slowdown reflects the slow pace of structural reforms and the resulting loss in competitiveness—lately aggravated by expansionary wage policies. The continuation of a system of large transfers from enterprises to households (notably via a host of subsidies and increasingly higher wage bills) has squeezed enterprises’ profits, limited their ability to invest, and thus jeopardized medium-term growth prospects. Without a fundamental change in policies, current plans for a monetary union with Russia will be more difficult to achieve.

2. Belarus has been losing ground against its main external competitors. Most indicators using price index data and the parallel market exchange rate, as well as cost-based indices, point to a loss in competitiveness in recent years. Favorable export performance, in particular during 2000-01, seems to be temporary, largely limited to industries where Belarus has a quasi-monopolistic share in the markets of Russia and other CIS countries. As a result, the current account surplus observed in the first half of 2001 could turn into a deficit in the near future. Competitiveness issues are discussed in Chapter II.

3. The increasing fragility of Belarus’s real economy has been compounded by the government’s wage policies. Large wage increases have been granted in the past two years, especially in 2001, following the President’s promise of an average monthly wage equivalent to $100. This policy has put considerable pressure on the budget, foreign exchange market, banks and enterprises. In particular, the budgetary wage bill jumped from 6 percent of GDP in 2000 to an estimated 9 percent in 2001, while the overall wage share is expected to have risen from 34 percent of GDP to 39 percent during the same period. While the authorities have taken initial steps to reform the wage system, including by delinking part of the government sector from a rigid wage grid, wage hikes threaten to unwind the hard-won stabilization gains achieved to date. Belarus’s wage policy is reviewed in Chapter III.

4. The government has made progress in reducing subsidies recently, largely by eliminating the existing multiple currency practice in September 2000. However, phasing out subsidies implicit in controlled utility prices has been more difficult. After years of decline, since the beginning of 2001 cost-recovery in most utilities has improved, but from a very low base. Despite those initial steps, Belarus still maintains extensive budgetary and implicit subsidies and cross-subsidies. Most subsidies are costly, poorly targeted, and unlikely to improve income distribution. By distorting price signals and leading to productive expenditure squeeze, subsidies may have also adversely affected economic growth prospects. An overview of Belarus’s subsidies is presented in Chapter IV.

5. Against the background of its longstanding structural problems, Belarus faces a major policy challenge—to create a stable macroeconomic environment and achieve economic convergence with Russia by 2005. A review of the costs and benefits of the prospective monetary union with Russia, is summarized in Chapter V. The analysis suggests that, while the union could encourage economic reforms and increase trade with Russia, it would also have significant drawbacks, especially given that the two economies are subject to different external shocks (e.g., Russia is a large energy exporter while Belarus imports most of the energy products it consumes). Without wide-ranging structural reforms that would help Belarus to adjust to these shocks and an appropriate mechanism of fiscal transfers, these shocks could complicate unified economic policy. Taking the union objective as given, a more flexible exchange rate policy may be needed during the transition period toward monetary union, especially in view of the relatively rigid labor markets in Belarus.