This 2001 Article IV Consultation highlights that the authorities in Belarus made headway in 2001 in further liberalizing the foreign exchange market and stabilizing the exchange rate and reducing inflation. They also took steps to liberalize prices and initiate other structural reforms. At the same time, a policy of raising wages to unaffordable levels during an election year undermined progress achieved in stabilization. Significant progress was achieved under a Staff-Monitored Program, covering April 1–September 30, 2001. Monetary/exchange rate policy was implemented successfully, and the benchmarks for structural reforms were largely met.

Abstract

This 2001 Article IV Consultation highlights that the authorities in Belarus made headway in 2001 in further liberalizing the foreign exchange market and stabilizing the exchange rate and reducing inflation. They also took steps to liberalize prices and initiate other structural reforms. At the same time, a policy of raising wages to unaffordable levels during an election year undermined progress achieved in stabilization. Significant progress was achieved under a Staff-Monitored Program, covering April 1–September 30, 2001. Monetary/exchange rate policy was implemented successfully, and the benchmarks for structural reforms were largely met.

I. Background to the Discussions

A. Overview

1. Economic policies and developments in 2001 continued to improve markedly, particularly when compared with Belarus’s track record in the mid- and late-1990s. This progress came on the heels of the exchange rate unification in September 20001 and benefited from significant success in implementing a Staff-Monitored Program (SMP) with the Fund. During the past year the authorities made headway in further liberalizing the foreign exchange market, stabilizing the exchange rate, and reducing inflation; they also took steps to liberalize prices and initiate other structural reforms. At the same time, a policy of raising wages to unaffordable levels—in line with the President’s pre-election promises—undermined progress achieved in stabilization.

2. While inflation and current account developments have been relatively favorable, the situation in the real sector remains difficult, clouding prospects for 2002 and beyond. This reflects the strained financial situation of enterprises and banks due to insufficient economic restructuring, an increasingly obsolete capital stock, and an unfavorable business environment. These longstanding problems have been compounded by substantial wage increases during the last two years. Against that background, the fiscal situation is becoming increasingly fragile, given the trend toward lower revenue, a higher budgetary wage bill, and a dearth of non-inflationary sources of deficit financing. Pressure on the budget has in turn led the National Bank of Belarus (NBB) to ease monetary policy, against a generally tighter stance since the exchange rate unification. Balance of payments developments have been positive but remain uncertain.

B. Economic Developments in 2000-01

Inflation has receded during the past couple of years, but economic growth is decelerating (Figure 1 and Table 1). Real GDP grew by 3 percent in January-October 2001, compared to 5 percent during the same period in 2000 (and 6 percent for 2000 as a whole). However, measured output growth in 2001 masks an underlying weakening of economic activity, as suggested by the rising levels of inventories, non-cash transactions and domestic arrears, the low level of profits and investment, and sagging competitiveness. Despite some price liberalization, inflation continued the downward trend initiated at the end of 1999. Year-on-year CPI inflation dropped from 108 percent in December 2000 to 47 percent in October 2001.2 However, monthly inflation picked up recently (from 0.8 percent in August to 3.6 percent in October) owing to further price liberalization, wage increases, monetary easing in the second quarter, and administrative price increases that had been postponed until after the September election.

Figure 1.
Figure 1.

Belarus: Selected Indicators, 1996-2001

Citation: IMF Staff Country Reports 2002, 023; 10.5089/9781451805093.002.A001

Source: Belarusian authorities; and Fund staff estimates.

4. The external current account improved markedly. The deficit narrowed to $162 million (1.3 percent of GDP) in 2000, mainly due to a significant recovery in agricultural exports (on account of good weather) and a pickup in transit services receipts. A surplus of $240 million (4.5 percent of GDP) was posted during the first half of 2001 because of large exports to Russia and a fall in imports, partly due to lower energy prices. This turnaround in the current account did not reflect improved competitiveness (Box 1). The current account is expected to be close to balance in the third quarter. Gross official reserves increased by $48 million in 2000, reaching $357 million at end-December. They dropped to $338 million at end-September 2001 (0.7 months of imports), as the NBB intervened to keep the exchange rate within the targeted band during the summer, when demand for dollars increased on account of higher wage incomes. At the same time, the disbursement of the first tranche ($54 million) of a stabilization loan from the Central Bank of Russia (CBR) helped ease pressures on the exchange market. During 2000 Belarus remained current on its external energy payments. After declining by $45 million in 2000, the stock of energy-related arrears picked up in the first half of 2001, albeit on a much smaller scale.

5. Following the exchange rate unification, the NBB effectively shifted to targeting the rubel/dollar exchange rate. In addition, at the end of 2000 the authorities announced the adoption of an “adjustable” crawling peg (in fact a crawling band) vis-à-vis the Russian ruble, in line with the objective of achieving a monetary union with Russia by 2005. The new system featured a band of 2 percentage points around central parity (recently enlarged to 5 percentage points) and pre-announced monthly devaluations, revised each quarter. So far, this has allowed the targeting of both rates to be compatible. The rubel depreciated against the dollar by 2.5 percent per month on average during January-November 2001, somewhat slower than envisaged, reflecting the unexpected external current account surplus in the first half of the year and NBB intervention. A 5.2 percent depreciation of the real effective exchange rate was observed during January-September 2001. However, it remains overvalued, given the steep real appreciation of the parallel rate prior to exchange rate unification (Figure 2). Since the unification, exchange rate deviations between the daily auction and the over-the-counter interbank market have remained within a 2-percent margin.

External Competitiveness Weakens 1/

The exchange rate unification is likely to have improved the situation of the export sector somewhat, since it eliminated an implicit tax on export transactions. Prior to the exchange rate unification, 30 percent of foreign exchange proceeds from international current transactions had to be surrendered at the overvalued official exchange rate.

Empirical evidence suggests that strong export growth in 2000 and early-2001 may be reversed quickly, mainly depending on Russia’s growth performance:

  • Trade data show that exports have benefited from Russia’s economic recovery only in those industries where the country has a quasi-monopolistic share in the markets of Russia and other CIS countries (for example, vehicles, machinery, textiles, and chemical products).

  • Labor cost index-based measures of external competitiveness indicate that the Belarusian exporters have been losing ground markedly against their main competitors in recent years.

  • Price index-based indicators using the parallel market exchange rate until September 2000 (the date of exchange rate unification) point strongly in the same direction.

By contrast, price index-based indicators using the official exchange rate point to a moderate improvement of Belarus’s external position. However, this result is likely to be distorted by price and exchange rate data, reflecting significant price controls and the existence of exchange controls until 2000.

1/ This box summarizes Chapter II of the Selected Issues Paper.

6. Real wages rose steadily during 2000–01. Budgetary sector wages were boosted in three steps between March and July 2001, reaching an average of $88 in September, within the overall drive to fulfill the Presidential promise of a $100 average monthly wage in the budgetary sector by the end of the year. Economy-wide average wages also rose sharply, reaching the equivalent of $97 per month at end-September 2001, compared to $76 at end-2000.3 This policy had a negative impact on the budget as well as on enterprise profitability and investment activity, since in practice enterprises were not allowed to reduce employment. As a consequence, it encouraged enterprises to defer tax payments and triggered a generalized accumulation of domestic payments arrears (Box 2).

Figure 2.
Figure 2.

Belarus: Real Exchange Rate Developments, January 1997-2001 1/

Citation: IMF Staff Country Reports 2002, 023; 10.5089/9781451805093.002.A001

Source: National Bank of Belarus; and Fund staff estimates.1/ An increase indicates an appreciation.2/ The “parallel market rate” used here is the interbank noncash market rate. Until October 1998, this rate was based on the Moscow interbank market rate.

Wage Policy 1/

Since 1997 real wages in Belarus have risen steadily, doubling their 1996 level in 2001, despite a significant slowdown in output growth—real output grew much less rapidly during the same period (by a cumulative 32 percent). Real wage growth accelerated in 2001, following the President’s promise to lift the average monthly wage to the rubel equivalent of $100. In the budgetary sector, the wage bill increased from 6 percent of GDP in 2000 to an estimated 9 percent in 2001. At the same time, labor productivity has lagged behind real wage increases.

Raising wages to an arbitrary target of $100, in the absence of a corresponding gain in productivity and of enterprise flexibility to lay off workers, has put pressure on the budget, enterprises, foreign exchange market, and inflation.

  • This wage policy undermined the ability of enterprises and banks to pay taxes and to contribute to social funds, led to a squeeze of other budgetary expenditures, and resulted in a larger fiscal deficit.

  • The higher wage bills cut significantly into enterprise profits, thereby reducing investment.

  • The additional wage income put pressure on the exchange market as households’ demand for dollars increased. NBB intervention to keep the exchange rate stable led to reserve losses.

  • Thus far, households have largely saved their recently acquired foreign exchange. However, spending of these funds in the coming months could erode the recent progress in fighting inflation. If monetary policy were tightened to avoid price increases, this could lead to a further accumulation of arrears.

1/ This box summarizes Chapter III of the Selected Issues Paper.

7. After a significant tightening in 2000, fiscal developments in 2001 have been shaped by efforts to cut expenditures to offset increases in budgetary wages. While the consolidated fiscal deficit (cash basis) was limited to 0.6 percent of GDP in 2000, it is projected to increase to around 1.8 percent in 2001 (Figure 3). At the same time, expenditure arrears started to accumulate since the beginning of the year, particularly at the local government level; tax arrears also gathered pace. Revenues have been below expectations, especially with regard to value added and profit taxes, partly due to higher-than-anticipated demand for VAT refunds and falling enterprise profitability. The balance of the Social Protection Fund has deteriorated recently as a result of declining contributions, delayed transfers from the central government, and rising expenditure obligations (mostly related to an increase in the pension/wage ratio).4

Figure 3.
Figure 3.

Belarus: Consolidated Revenues, Expenditures, and Fiscal Balance, 1996-2001

Citation: IMF Staff Country Reports 2002, 023; 10.5089/9781451805093.002.A001

Source: Belarusian authorities, and Fund staff estimates.

8. The monetary policy stance was tightened in 2000-01. Nevertheless, it was more expansionary than envisaged during the second half of 2000 and the second quarter of 2001. The former reflected a buildup of international reserves and an increase in the money multiplier due to a deterioration of compliance with statutory reserve ratios, related to banks’ extension of directed credits to agriculture at the instruction of the government. Monetary expansion in the second quarter of 2001 reflected a jump in cash in circulation and household rubel deposits with banks, following the spring wage hike and enterprises’ switch to cash settlement.5 Money growth slowed down again in the third quarter, reflecting NBB net sales of foreign exchange to households, but is expected to pick up toward the end of 2001 to accommodate additional government financing needs. After the exchange rate unification, some remonetization took place, reflecting increased confidence and the maintenance of positive real interest rates on rubel deposits.

9. Some steps were made to initiate structural reforms, but the outstanding agenda remains large. In particular, the authorities made major headway in foreign exchange liberalization and started to dismantle the extensive system of price controls. In addition, Decree No. 40, allowing extrajudicial seizure of properly from individuals responsible for damage to the State, was revoked in mid-November 2001. A new investment code was adopted in October 2001, providing new safeguards for domestic and foreign investment. A strategy for implementing a targeted social safety net during the period 2001–03 was developed in cooperation with the World Bank to streamline the current system of subsidies and privileges and to improve cost effectiveness. A pilot project is to be implemented during 2002. Despite recent efforts to improve cost-recovery and cut subsidies, the latter remain sizeable (Box 3).

Subsidies at a Glance 1/

Belarus operates an extensive and costly system of direct and implicit subsidies that reduces fiscal transparency and misallocates resources. Consumer subsidies tend to be poorly targeted, while producer subsidies favor certain privileged sectors (e.g., agriculture and construction). Cross subsidies represent transfers from enterprises to households via differential tariffs. With the exchange rate unification in September 2000, large subsidies implicit in the multiple exchange rate system were eliminated. However, remaining subsidies are pervasive. Staff estimates of selected subsidies are given below (as percent of GDP, for 2000).

  1. Direct budgetary subsidies (about 2 percent).

  2. Implicit gas import subsidy (up to 13½ percent).

  3. Implicit consumer subsidies (6–7 percent).

    1. price controls.

    2. underpricing of utility tariffs.

    3. noncash subsidies (free provision) to limit households’ utilities expenditures.

    4. free communal services for certain groups of the population.

    5. cross subsidies.

  4. Implicit producer subsidies (8-9 percent).

    1. tax preferences.

    2. interest rates subsidies.

    3. directed credits via commercial banks.

    4. tax and energy arrears.

    5. non-performing loans.

Cost estimates for different groups of subsidies are not additive. For example, the gas import subsidy is reflected in domestic consumer subsidies on electricity, gas, and heating. The implicit gas import subsidy from Russia also benefits Belarus’s energy, electricity, and heating companies, as well as domestic consumers, who pay below-market prices for energy. At the same time, some producer subsidies have cross-subsidizing elements reflected in the corresponding category of consumer subsidies.

1/ This box summarizes Chapter IV of the Selected Issues Paper.

10. The banking sector remains fragile. The already weak financial position of commercial banks was aggravated in 2001 by the deteriorating situation of their main corporate clients. While short-term vulnerabilities remain limited in light of continued widespread government ownership and financial support, the current situation is not sustainable (Box 4).

Banking Sector Remains Fragile

The Belarusian banking sector is dominated by six core banks—Belarusbank, Agroprombank, Promstroibank, Vnesheconombank, Priorbank, and Belinvestbank. These banks account for about 90 percent of total banking system assets, 90 percent of enterprise lending, and almost 100 percent of lending to households. More than 90 percent of household deposits are held with the core banks. The state directly owns a majority share in three of these banks and a significant minority share in the others. The NBB itself continues to maintain shares in several of them. Banking sector assets amounted to less than 30 percent of GDP at the end of 2000, according to the authorities.

The financial situation of banks continues to deteriorate. Bad loans increased by 48 percent during January-September 2001, reaching about 15 percent of total loans. At the same time, the loan provisioning classification system underestimates the extent of impaired assets. Government guarantees given to banks have often not been honored and some banks face increasing risks of defaults on agriculture-related lending. Additional pressure has come on the heels of recent wage increases, since some enterprises have reportedly borrowed to meet their higher wage bills.

Despite a weakening of the banking sector, short-term vulnerabilities remain limited in light of continued widespread government ownership and financial support. While the banks’ capital base increased by 10 percent during the first six months of 2001, partly owing to a Rbl 26 billion capital injection by the NBB, in May 2001 the direct and indirect government ownership of 15 banks was still equivalent to more than 96 percent of authorized capital. Major banks have been repeatedly “recapitalized” and the NBB routinely provides liquidity support to troubled institutions.

Serious long-term vulnerabilities can only be addressed adequately by restructuring the corporate sector and reducing both government majority ownership of bank equity and the authorities’ involvement in bank management. A number of recent regulatory and supervisory improvements, while welcome, are not likely to halt or reverse the process of deterioration of the banking sector.

The authorities’ recent Banking Development Program for 2001-10 recognizes these problems, but falls short of presenting a comprehensive set of adequate structural reforms in the financial and corporate sectors.

11. Despite some liberalization, Belarus’s trade regime continues to be rated 8 under the Fund’s trade restrictiveness index. This rating results from an unweighted average tariff rate of 12 percent in 2001, combined with: (i) export quotas; (ii) export licensing requirements; (iii) export price controls; and (iv) foreign exchange surrender requirements. Since the last Article IV consultation, the weighted average tariff rate has decreased by one percentage point (to 9 ½ percent); foreign exchange restrictions on international current transactions have been removed; and the ceiling on the mark-up on imported goods has been withdrawn. The authorities are considering shortening the list of activities subject to licensing and removing the surrender requirement on Russian ruble transactions. Belarus has almost fully harmonized its tariff structure with Russia and is currently in the process of unifying its tariffs with some other members of the Eurasian Economic Association. A third round of negotiations for WTO accession took place in 2001; the authorities are working on amendments to the requisite legislation.

II. Performance under the SMP (April 1–September 30)

12. The six-month SMP played a positive role in steering economic policies toward macroeconomic stabilization and market reforms in 2001. A considerable tightening of financial policies contributed to a marked decline in inflation and relative exchange rate stability. The liberalization of the foreign exchange market achieved during the SMP period allowed Belarus to accept the obligations of Article VIII, Sections 2, 3, and 4 of the IMF’s Articles of Agreement on November 5, 2001. Some progress was made in structural reforms, including price liberalization. However, there were slippages in the fiscal area, largely as a result of aggressive wage policies that attempted to raise wages beyond the levels justified by productivity gains. Despite significant progress on a number of fronts, SMP implementation fell short of establishing the track record necessary to initiate discussions on a Stand-By Arrangement (tables 2 and 3).

13. All end-June and end-September monetary targets were met. Net lending to the government by commercial banks was in line with the SMP, but NBB lending to the government exceeded program assumptions. A large buildup in banks’ deposits with the NBB during the SMP period helped achieve the end-September target on NBB net domestic credit. Rubel broad money growth exceeded somewhat the indicative targets under the SMP, as detailed in paragraph 8. Gross reserves fell by $34 million during the SMP period, as envisaged under the SMP. Repayments to the Fund ($31 million) were made on schedule.

14. The fiscal program was thrown off track by expansionary wage policies. While the end-June fiscal deficit target was met, the targets for tax and expenditure arrears were missed. Despite efforts to contain non-wage expenditures, the consolidated fiscal deficit (cash basis) exceeded the end-September target by 0.4 percent of January-September GDP. Central government expenditure arrears exceeded the target by 0.5 percent of same period GDP, while the target for consolidated tax arrears was missed by a small margin. At the same time, local government expenditure arrears (not formally monitored under the SMP) increased by about 0.8 percent of period GDP during January-September. While utility tariffs were raised sharply during the SMP period, local subsidies for communal services and transportation were not cut as expected.

15. As in 2000, the fiscal deficit was financed mainly by net credits from the NBB, given the government’s difficulties in borrowing from other domestic or external sources. In mid-2001, the first tranche ($30 million) of a loan from the Russian government was disbursed. The government also issued modest amounts of short-term dollar-denominated bonds, mainly to Russian investors and local banks.

16. Most structural benchmarks were met, albeit with a delay in a few cases (table 3). The structural benchmarks related to monetary and credit policies, the banking sector, privatization and the business environment, wage liberalization, and agriculture were met. Except for one temporary exemption, all ad hoc exemptions to the surrender requirement were removed in early November 2001. Exchange restrictions on cash bureaus, the interbank market, and the non-resident market were removed.6 Regarding fiscal policy, the revised 2001 budget was not in line with the fiscal program committed under the SMP.

17. Significant progress was made on price liberalization, although SMP requirements were not fully met. Four structural benchmarks were fully implemented, and two benchmarks related to the liberalization of prices of socially important goods were partially implemented (the list of controlled goods was reduced by 45 percent instead of the minimum 73 percent agreed).7 The liberalization of at least 15 goods and services under ministerial price control is now expected to be completed by the end of 2001. As a result of the liberalization measures, the number of consumer goods and services subject to price controls was reduced from a weighted 27-30 percent of the CPI basket at the beginning of 2001 to 20-22 percent by end-November.8 The authorities are planning further price liberalization in 2002.

18. The information provided to the staff showed that, following the gradual lifting of limits on exchange transactions, there were no further restrictions subject to approval under the Fund’s jurisdiction, and the authorities have accepted obligations of Article VIII, sections 2, 3, and 4. Segmentation between various exchange markets has been largely eliminated and the NBB has modified its policy for payments and transfers for international current transactions on behalf of the government. While the surrender requirement must be conducted at the Belarus Currency and Stock Exchange, this does not give rise to a multiple currency practice, since it is the NBB’s policy, through market participation, to maintain exchange rate deviations between market segments within a 2-percent margin. Consequently, no multiple currency practices remain.

19. The authorities felt that Belarus’s performance under the SMP had been stronger than acknowledged by the staff. They noted the important role of the SMP in steering policies in the right direction, but emphasized their efforts to meet SMP targets during an election year. They observed that most structural benchmarks had been met and that the delays in completing a few of them had been due to administrative hurdles associated with the change in government following the presidential election; most of the delayed measures were implemented in November and the remaining benchmarks on price liberalization are expected to be put in place before end-2001. The authorities also claimed that the fiscal slippages under the SMP were relatively small, and did not warrant an overall negative assessment of program performance. Furthermore, the wage increases, although clearly linked to the presidential elections, were also intended to allow for a sharp reduction of utility cross-subsidies and budgetary subsidies for transportation. While the authorities vowed to pursue the policies recommended by the staff, they lamented that the lack of external financial support would make their task more difficult. The staff acknowledged the authorities’ efforts to comply with policy commitments and their relative success in implementing the SMP under the circumstances. The staff added, however, that the policy of targeting an unaffordable level of dollar wages was inconsistent with the SMP, and could in time compromise stabilization efforts and growth prospects in Belarus. Moreover, most understandings under the fiscal program had not been implemented. Therefore, it was not possible to consider the six-month track record as fully satisfactory.

III. Policy Discussions

A. Overview

20. Policy discussions focused on the need to: (i) address without delay the growing imbalances in the real sector to improve the medium-term outlook; and (ii) adopt consistent and sound macroeconomic policies in 2002 to preserve and extend stabilization gains.

21. The mission stressed that failure to restructure enterprises and accelerate market reforms could reverse hard-won stabilization gains, rekindle high inflation, and damage growth prospects. The authorities noted their intention, underpinned by various presidential statements, to step up privatization and the liberalization of the economy. They also pledged to continue their efforts to bring down inflation via tight financial policies. The new government would present an economic program along these lines to Parliament in December 2001. The mission welcomed the authorities’ plans to move forward with market reforms, but urged them to take concrete measures without delay to build much-needed credibility.

22. The mission reviewed the authorities’ macroeconomic framework for 2002 and noted inconsistencies between targets and policies. Their framework differs significantly from the staffs projections (tables 46) in the following areas: (i) the authorities’ projections of GDP growth, FDI, and privatization receipts appear to be overly optimistic; (ii) their planned wage increases are excessive, both from the point of view of productivity growth and availability of budgetary financing; and (hi) the targeted fiscal deficit (1.5 percent of GDP) and, in particular, the projected NBB credit to government, are inconsistent with the inflation target. In addition, the authorities’ stated preference for an exchange rate anchor is not backed by appropriately tight fiscal and wage policies.

23. The authorities insisted that their 2002 program was internally consistent, while including sufficiently ambitious growth and wage targets to motivate good performance. They expressed confidence that their plans for accelerating privatization and liberalizing the economy would help attract foreign investment, finance the budget deficit, and achieve a high rate of growth as early as 2002. They also noted that the planned wage increases for 2002 would be modest compared to 2001, and would be implemented together with off-setting cuts in cross-subsidies currently favoring households. They pointed out that NBB credit was essential for the government’s housing construction program, but was already projected to drop significantly as a percentage of GDP in 2002, in line with monetary targets. Finally, they added that support for a relatively fixed exchange rate under the proposed crawling band would be provided through a credit line from the CBR, and foreign direct investment.9 They also counted on a sizeable current account surplus, in contrast to the small deficit projected by the staff, to support their exchange rate target.

24. The mission pressed the authorities to adopt the new methodology for compiling the industrial production index (developed with Fund assistance) and thus avoid the current GDP overestimation in official statistics. While the new indices are being compiled, the authorities could not commit to a specific date for their publication, since further technical work was needed. They explained that their 5-year social development plan (including forecasts for all 118 districts of Belarus) was based on the old methodology, and that calculation of industrial production indices at the district level was still not possible under the new methodology.

B. Fiscal and Monetary Policies

25. The staff considered that the slippages in fiscal performance during the past year unveiled weaknesses in overall economic policy. Despite a continued reduction in the adjusted overall fiscal deficit (including quasi-fiscal operations), the cash deficit has started to rise and arrears have accumulated. This has been accompanied by a sharp increase in the wage bill, a rapid decline in capital expenditures, and shorter maturities of government securities. As a first step to strengthen the public finances, the mission recommended revising the draft 2002 budget before it was passed into law (in late December 2001) to incorporate more realistic macroeconomic assumptions and to improve the composition of public expenditures. In particular, the mission cautioned that basing the budget on overly optimistic growth assumptions (4–5 percent GDP growth, compared to 1.5 percent projected by the staff) would set the stage for revenue shortfalls and expenditure arrears. To reach consistency with monetary targets, the overall fiscal deficit would need to be limited to the level of available financing, which the staff projected at 0.7 percent of GDP-about half of the deficit targeted by the authorities. At the same time, the mission welcomed the authorities’ plans to ease the tax burden on enterprises, improve cost recovery on housing and utilities, rationalize the state administration workforce, and include off-budgetary funds in the 2002 budget. Fiscal transparency should be further improved by bringing any remaining special funds, including financial activities and transactions accruing to the Presidential Administration (usually referred to as the Presidential Fund), into the budget. Given the declining trend in budgetary revenues, the staff advised the authorities to carefully time the targeted cutback of the tax burden.10

26. The mission stressed the need for productivity-oriented wage policies. The planned wage increases for 2001-02 were not consistent with the objective of avoiding inflationary financing and curtailing budgetary arrears. In addition, the practice of targeting wages in dollar terms should be abandoned. The staff argued strongly for a more modest wage increase in 2002, so as to bring down the budgetary wage bill relative to GDP. As a first step in this direction, the staff urged the authorities to drop their plans to raise wages in December 2001. Finally, the authorities should explicitly authorize enterprises to set their wages independently of budgetary wage policies.

27. The authorities conceded that wage pressures were the most significant factor affecting fiscal performance in 2001, but remarked that they also had to struggle with some defaults on government-guaranteed loans and with higher-than-anticipated demand for VAT refunds.11 They recalled that the 2001 was an election year and indicated that the wage increase planned for December would have to be implemented.12 However, wage hikes in 2002 would be much more modest. The authorities were also more optimistic on revenue prospects for 2002, based on their higher output growth assumption.

28. A tighter monetary policy than envisaged by the NBB would be needed in 2002 to underpin the authorities’ inflation target (20–27 percent). The authorities’ targets for NBB credit to the government (about 0.7 percent of GDP) and overall money growth (about 40 percent) are not consistent with their inflation objective. The staff projected a more modest increase in NBB credit to government (0.3 percent of GDP), consistent with money growth of 28 percent and an inflation rate of 26 percent. Since most NBB credit to the government is earmarked for housing construction, the staff recommended a significant scaling down of that program, allowing a greater degree of private sector financing of housing construction. The authorities insisted that the provision of affordable housing to the population was an essential element of their development strategy.

C. Exchange Rate Policy

29. The authorities expressed a strong preference for exchange rate targeting. They believed that exchange rate unification, the liberalization of the exchange market, and the policy of targeting the exchange rate had considerably enhanced central bank credibility. They argued that, compared to monetary aggregates, an exchange rate target was more transparent and easier to monitor. In addition, monetary targeting was less effective in a country such as Belarus, where there were no clear transmission mechanisms of monetary impulses. In their view, a change to targeting monetary aggregates—which had not worked well in the mid-1990s—could ignite inflationary and devaluation expectations and result in a loss of credibility.

30. While sympathetic to the authorities’ arguments, the mission pointed out that the appropriate supporting policies to ensure successful exchange-rate based disinflation were not in place in Belarus. The use of an exchange rate anchor would require a strict fiscal stance, an adequate level of reserves, a substantial acceleration of structural reforms to ensure export competitiveness, and more flexibility in labor policies, all of which were missing. On the contrary, overall economic policies appeared to run counter to a fixed exchange rate approach. The staff was also concerned about the implications of the authorities’ combined policies of exchange rate and wage targeting for external competitiveness, which seemed to be deteriorating. Under the circumstances, the staff urged the authorities to adopt a more flexible exchange rate policy. The rate of crawl and the band should be sufficient to avoid an exchange rate overvaluation.

31. The authorities conceded that the current policy could have negative implications for export competitiveness, but expressed hope that acceleration of structural reforms would moderate this effect. Indeed, after using exchange rate unification to successfully push for price and exchange rate stability, the NBB hoped to use exchange rate stability and the integration process with Russia to push for structural reforms. The authorities also noted that their exchange rate policy was relatively flexible, given the allowable band and the quarterly review of monthly targets. The NBB’s monetary policy guidelines aimed at avoiding a real appreciation vis-à-vis the Russian ruble, which would entail a small appreciation against the dollar. They added that, with very limited capital account convertibility, there was little risk of speculative capital flows, which would indeed require a more comfortable reserves cushion. At the same time, restricted capital convertibility would restore some of the independence of monetary policy, even in an exchange rate targeting framework.

D. Structural Policies

32. The mission urged the authorities to move decisively on structural reforms. Top priorities would be to complete price liberalization and remove impediments to private sector development. Measures to improve the business environment, enforce hard-budget constraints, increase the transparency of fiscal policy, ensure legislative stability, and generally reduce government interference would, in due course, encourage investment and growth.

33. The authorities confirmed their plans to accelerate structural reforms in 2002. They noted that the lack of investment was a major constraint for economic development in Belarus and were determined to improve the climate for private business. The new government planned to reduce administrative pressures, obstacles and interference, and encourage development of small and medium-sized enterprises. The intention was to complete price liberalization (leaving under control only natural monopolies and a narrow range of socially important goods), raise cost-recovery13, reduce cross-subsidies in utility pricing, ease registration and licensing requirements, and cut the tax burden on enterprises.

34. The mission was encouraged by the authorities’ statements, but urged them to be more concrete and ambitious. The staff recommended deeper and across-the-board subsidy cuts to encourage investment and growth and ensure a level playing field. At the same time, the authorities should speed up the implementation of a targeted social safety net. The mission urged the authorities to make their privatization plans public at the earliest opportunity and to seek advice from the World Bank and EBRD before embarking on large-scale privatization. In light of the experience of other countries, the adoption of transparent procedures and competitive sales would be key to achieving positive results in the privatization process.

IV. Medium-Term Outlook and the Balance of Payments

35. Medium-term economic prospects to a large extent depend on the terms of the planned economic integration with Russia and on Russia’s growth performance. They are also sensitive to the government’s wage policies and ability to implement structural reform. To illustrate medium-term prospects, the staff prepared two scenarios, based on a slow-adjustment path and an accelerated-adjustment path (Appendix V). Both scenarios assume the same economic conditions in Russia but only the latter ensures the convergence needed for a monetary union in 2005. While implementation of the December 1999 Union Treaty continues to be complicated by differences in economic structure and economic policies in the two countries, the process of integration with Russia may encourage market reforms.14 While the impact of lower oil prices in 2001 has been taken into account in the projections, the downside risks would be amplified by further drops in oil prices and any increase in the negotiated price of natural gas, imported from Russia. The resulting deterioration in the current account would require tighter fiscal policy and more exchange rate flexibility.

36. Under current policies, medium-term balance of payments prospects are clouded by low competitiveness and external financing constraints. While the accumulation of external payments arrears and large swings in suppliers’ credits would help overcome financing difficulties in the short-run, large financing gaps can only be prevented with continued strong Russian demand for Belarusian industrial goods. Belarus’s competitiveness in international markets continues to suffer from insufficient enterprise restructuring, high labor costs, and administrative obstacles to exports. The dependence on the Russian market and Russian financing sources implies long-term vulnerabilities, as evidenced by the 1998 crisis.

37. Both debt and debt service levels continue to be moderate by international comparison. However, the outlook is fragile in light of the low level of official reserves and high levels of short-term debt and arrears. Other than the third tranche ($52 million) of a CBR stabilization loan and the third tranche ($42 million) of a loan from the Russian government, little external financing is likely to be forthcoming in 2002, in contrast to the authorities’ more optimistic projections. In view of its relatively low debt burden and good repayment record, the staff expects that Belarus will continue to meet its obligations to the Fund in a timely fashion.

V. Staff Appraisal

38. Following the successful unification of exchange rates in September 2000, the Belarusian authorities stepped up their efforts to adopt sound macroeconomic policies and initiate market reforms. Positive results were achieved in price and exchange rate stabilization, and all exchange restrictions on international current transactions were removed. In addition, the authorities started to dismantle the extensive price control system, phase out directed credits, improve the business environment, and put in place a targeted social safety net. Finally, the recent revocation of Decree No. 40, allowing extra judicial seizure of property, is an important signal of the authorities’ intention to accelerate structural reforms.

39. Against that background, the government’s attempt to put in place a wage-led development strategy is a major setback. The policy of targeting dollar wages higher than can be afforded by productivity gains has already undermined fiscal performance, weakened the fragile enterprise sector, and fostered a—hitherto absent—nonpayments culture. Most importantly, looking ahead, this policy jeopardizes medium-term growth prospects. Therefore, the staff strongly urges the authorities to reconsider the wage policy and to refrain from setting wage targets in foreign currency terms.

40. Nevertheless, significant progress was achieved under the SMP in certain areas. The staff agrees with the authorities that the SMP played an important role in providing a framework for policy implementation, supporting the momentum for reform, and enhancing NBB credibility. During the six-month program, all monetary targets were achieved and the structural benchmarks were largely implemented. However, the decision to raise dollar wages beyond the levels that the economy could afford was inconsistent with the SMP. As a result, the fiscal program departed significantly from SMP commitments and the track record of policy implementation was not as good as it might have been.

41. The staff could not support the authorities’ financial program for 2002. Since the authorities’ projections of key macroeconomic parameters were not considered realistic by the staff, negotiations on a possible track-record SMP for the first half of 2002 stalled. Against that background, discussions on a concrete structural reform program could not advance. The staff urges the authorities to reconsider their macroeconomic framework and revise the 2002 budget, monetary policy guidelines and other projections along the lines proposed by the staff. In particular, the wage bill would need to be brought in line with economic and financial realities.

42. Without these revisions, there is a clear danger of a further buildup of arrears, additional pressure on the budget, enterprises, and banks, and increased expectations of monetary easing. In addition, the exchange rate could come under pressure and the credibility earned with exchange rate unification and liberalization of the exchange market could be lost. At the same time, the authorities should use the flexibility allowed under the crawling band arrangement to avoid a further erosion in external competitiveness. Given the economy’s high degree of openness, the acceleration of structural reforms would be crucial in that regard.

43. While macroeconomic developments have been relatively favorable, the downside risks remain large in the medium-term. The growing imbalances in the real sector need to be addressed without delay to avoid a reversal of the recent progress in stabilization and liberalization. The structural reform agenda is extensive and challenging. In the immediate future, there is a pressing need to complete price liberalization, level the playing field for businesses, accelerate privatization, and reduce government interference in the economy. Banking reform also needs to be tackled, together with enterprise restructuring. At a general level, the authorities and Parliament have come to recognize that higher investment and growth can only be achieved through market reforms, and there is a growing public debate on these issues. Nevertheless, the authorities’ ability to show a credible commitment to a comprehensive and consistent reform program has still to be established.

44. The staff commends the authorities for the liberalization of the exchange market. In view of the removal of all exchange restrictions on international current transactions, the staff welcomes the authorities’ acceptance of the obligations of Article VIII, sections 2, 3, and 4 on November 5, 2001.

45. While the compilation of balance of payments statistics and national accounts has been improving steadily, the quality of some basic statistics is still deficient. Fiscal reporting has improved markedly, but there is still a need to expand coverage of fiscal data, especially to include off-budget transactions—such as the Presidential Fund—which mask the overall fiscal picture. Official GDP figures are overestimated by the current method of measuring industrial output; the new method should be adopted as soon as possible. The authorities should address these problems urgently to improve the quality of policy formulation.

46. The Belarusian authorities have made important moves toward market reform. However, substantial effort will be required to sustain the momentum for reform, adopt consistent and sustainable policies, and build consensus around reform programs. Policy and technical advice from the Fund has an important role to play at this juncture. In particular, the macroeconomic framework and structural reform program proposed by the staff would go a long way toward ensuring policy consistency and placing the economy onto a sustainable growth path.

47. The next Article IV Consultation with Belarus is expected to be held on the standard 12-month cycle.

Table 1.

Belarus: Selected Economic Indicators, 1996-2002

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Sources: Belarusian authorities; and Fund staff estimates.

Valued at the official exchange rate.

The Belarusian national accounts overstate real growth by about 1-2 percent. A new industrial production index, which would correct the estimates is calculated but not published.

Valued at the parallel exchange rate and on a period average basis

Exchange rates reflect the authorities decision to drop three zeros from the rubel denomination, effective January 1, 2000.

The parallel rate is the offshore rate in Moscow until 1997 and the domestic noncash interbank rate outside the Belarus Currency and Stock Exchange from 1998 until the unification of exchange rates in September 2000.

Consolidated budget; includes an adjustment for the discrepancy between actual monetary and fiscal data during 1996-1999.

January-October

January-June

Including Rbl 26 billion for the recapitalization of Belarusbank.

Table 2.

Belarus: Quantitative Targets for the Staff-Monitored Program, April 1-September 30, 2001 1/

(In millions of rubels, unless otherwise indicated; end-period data)

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For definitions of the variables that constitute quantitative targets, see Annex II of the Memorandum of Economic and Financial Policies (MEFP) attached to EBS/01/58 (April 23, 2001). The end-December 2000 data and the program ceilings on the stock of net domestic credit of the National Bank of Belarus, the increase in net bank credit to general government, as well as the floor on net international reserves of the National Bank of Belarus are revised compared to the MEFP to reflect adoption of a new chart of accounts for the commercial banks.

Indicative

For the purpose of this calculation, any foreign components are valued at the program exchange rate of Rubel 1, 180 per $1.

Cumulative from January 1, 2001.

Excluding government lending funds.

Actual data include securities issued for honoring called state guarantees.

Table 3

Belarus: Structural Benchmarks under the SMP, March-September 2001

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A schedule was presented to Fund staff at end-September but has not been agreed.

Granted exemptions expired at the end of the program period (end-September 2001)

With a delay. The decree was revoked on November 13, 2001

Source: Table 6 of EBS/01/58 (April 23, 2001)

Table 4.

Belarus: Monetary Accounts, 2000-02

(In millions of Belarussian rubels, unless otherwise indicated; end-of-period)

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Sources: National Bank of Belarus; and Fund staff estimates.

Revised due to changes in the chart of accounts of commercial banks as of January 1, 2001

Excluding government lending funds.

Actual data includes securities issued for honoring called state guarantees.

Table 5.

Belarus: Summary of General Government Operations, 1999-2002

(In percent of GDP; unless otherwise indicated)

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Sources: Belarusian Ministry of Finance; and Fund staff estimates.

Excluding transfers between different levels of government. Consolidated balance does not add up to the underlying balance and the difference between revenues and expenditures of the social protection fund (SPF) due to inter-governmental consolidations involving budgetary funds, local budget funds, and SPF.

For actual 2001 data, expenditures were adjusted for a drawdown of government deposits.

For 2002, staff revised projection includes Rbl 30 billion in privatization revenues. The 2002 budget includes Rbl 130 billion in capital revenues above the line.

2001 revised projection is based on the increase in wages on April 1 and July 1 2001 and a planned increase on December 1. For 2002 revised projection, the wage bill is assumed to increase by 4.6 percent and 1 percent in the second and third quarter, respectively.

Table 6.

Belarus: Balance of Payments, 2000-02 1/

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Belarusian authorities; and Fund staff estimates.

Revised data for 1999 and 2000 reflect the adjustment of all (current and financial accounts) transactions denominated in Belarusian rubels for the difference between the accounting exchange rate (the official exchange rate) and the exchange rate used in the transaction.

Stabilization loan from Russia in preparation for monetary union.

All accumulation, repayment, and forgiveness of arrears.

The authorities’ original plan to reduce external payment arrears by $30 million during 2001 went off track with the accumulation of new energy-related arrears of $48 million during the first quarter. Earmarked funds of $30 million related to the disbursement of a loan from Russia, were spent on the repayment of arrears during the second quarter.

Ratios for 1999 reflect the steep devaluation of the exchange rate.