Republic of Belarus: Staff Report for the 2003 Article IV Consultation

This 2003 Article IV Consultation states that Belarus made noticeable progress in some areas of economic reform over the past several years, but overall macroeconomic performance in 2002 was mixed. Inflation in 2002 was the lowest since Belarus became independent, yet it remains the highest in the Commonwealth of Independent States. Under current policies, the outlook for 2003 is broadly similar to the outcome for 2002. Inflation is expected at about 27 percent, and real GDP growth is likely to slow modestly to about 4 percent.


This 2003 Article IV Consultation states that Belarus made noticeable progress in some areas of economic reform over the past several years, but overall macroeconomic performance in 2002 was mixed. Inflation in 2002 was the lowest since Belarus became independent, yet it remains the highest in the Commonwealth of Independent States. Under current policies, the outlook for 2003 is broadly similar to the outcome for 2002. Inflation is expected at about 27 percent, and real GDP growth is likely to slow modestly to about 4 percent.

I. Economic Developments in 2002 and Early 2003

1. Macroeconomic performance in 2002 was mixed. Driven by consumption, reported real GDP growth was 4.7 percent, similar to the 2001 level.1 Industrial production rose by 4.3 percent, led by external demand for oil products, while the government-financed housing program fueled the construction sector. Services expanded by 7.1 percent, but agriculture performed weakly, growing by only 1.5 percent. The large administrative wage increases in late 2001—combined with a substantial real appreciation of the rubel—adversely affected corporate finances and the balance of payments. Public finances also weakened, and inventories of unsold goods and domestic payments arrears increased. Official reserves rose sharply at end-year, owing largely to one-off factors. In the absence of these inflows—which included one very large privatization transaction—the level of reserves would have remained critically low.


GDP and Industrial Output Growth

(y/y percent change)

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001


Breakdown of Demand Growth

(Percent contribution)

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

2. Inflation continued its downward trend, although it is still the highest among the countries of the Commonwealth of Independent States (CIS). The 12-month rate of inflation fell from 46 percent during 2001 to about 35 percent during 2002, reflecting comparatively tight fiscal and monetary policies in the first three quarters of the year, as well as relative exchange rate stability. Inflation picked up late in the year and during Ql 2003 owing to seasonal factors, increases in administered prices, and a significant relaxation in the stance of fiscal and monetary policy following the September 30 conclusion of a financial program agreed with Russia.


Money Growth and Inflation

(m/m percent change)

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

3. Administrative wage increases in late 2001 undermined external competitiveness and the finances of the corporate and public sectors in 2002. Real wages grew by 31 percent (y-o-y) during 2001 and by a further 8 percent during 2002.2 (Real productivity growth was about 5 percent in 2001 and percent in 2002.) Enterprises came under particular pressure to clear wage arrears at end-year, even at the expense of higher interenterprise arrears. Sharply increased costs meant that corporate profits declined precipitously, while the share of loss-making companies in industry rose. Officially, employment fell by 1.8 percent during 2002 while the unemployment rate increased from 2.3 percent to 3 percent. As much as 10 percent of the work force was underemployed, and the number of available vacancies fell by 25 percent.


Real Wages and Enterprise Profits

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001


Arrears and Credit to Economy

(Deflated by PP1, Jan 2000=100)

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

4. Fiscal policy was marked by weak revenue performance and tight financing constraints. Weak enterprise profitability meant that corporate income and payroll taxes were particularly soft, though VAT receipts were relatively buoyant, owing to strong consumption growth. Government expenditure continued to be affected by the 2001 wage increases and the commitment to maintain or increase spending on priority social areas. At the same time, the poor performance of the agriculture sector and the need to prop up commercial banks put an additional burden on public finances. The fiscal balance, after remaining reasonably tight for most of 2002, expanded in December to yield a cash deficit of 1.8 percent of GDP for the year (1.9 percent on an accrual basis, as substantial arrears were not accumulated). The authorities have been unable to place significant net amounts of domestic or external government debt. Quasi-fiscal activities continue to impose a heavy burden on the economy, and progress with tax reform has been mixed. Although Part I of the new Tax Code is in place, plans to phase out the highly distortionary turnover tax have been postponed to ensure continued funding to the agriculture sector. In early December the government received proceeds from a hastily-arranged sale of its 11 percent stake in a major oil company, Slavneft.3

General Government Fiscal Developments

(In percent of GDP)

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Sources; MoF and IMF staff estimates.

5. The authorities took strong measures to stabilize the finances of the Social Protection Fund (SPF). The administrative wage increases in late 2001 undermined compliance on SPF taxes and caused statutory benefits to grow. After making unplanned transfers from the central government of about ¾ percent of GDP during the first half of the year, the authorities delayed indexation of benefits and broadened the tax base to include self-employed entrepreneurs. As a result, the SPF posted a small overall surplus for the year as a whole.4


Nominal and Real Refinance Rate

(In percent per annum)

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

6. Monetary policy in 2002 was tighter than in 2001. There was also some remonetization, reflecting a region-wide phenomenon.5 Reserve money growth slowed to 32 percent (from 103 percent in 2001), as the NBB sterilized excess liquidity in the first quarter and then loosened the stance of monetary policy during the second quarter (for the sowing season) and again toward end-year to accommodate additional government financing needs.6 Rubel broad money grew by more than 60 percent (compared to 97 percent in 2001), owing in part to lower reserve requirements on household rubel deposits (as well as lower effective reserve requirements overall). Indeed, household rubel deposits more than doubled in nominal terms as interest rates were held at very high levels until late in the year. The NBB gradually reduced the nominal refinance rate from 66 percent in January to 38 percent in November, keeping it at or above 20 percent in real terms during Q2 and Q3. However, real interest rates were allowed to fall below zero by end-year as inflation picked up once again.7

7. The exchange rate regime has become a source of vulnerability for Belarus. The NBB formally describes its exchange rate policy as a crawling band against the Russian ruble, in part because the authorities are aiming to establish a monetary union with Russia by 2005. De facto, however, the authorities seek to anchor inflationary expectations by identifying the band in terms of the U.S. dollar, a practice that had limited implications in 2002, due to the relative stability of the ruble/dollar rate. (Given the president’s commitment to average wage targets set in U.S. dollar terms, the monetary authorities face political pressure to engineer a real appreciation.) Moreover, 60-70 percent of banking system deposits are denominated in foreign currency, contributing to a “fear of floating.” As a result, by end-February 2003 the rubel had risen in real terms against the U.S. dollar by 20 percent since September 2001 (and by 6 percent against the ruble), undermining competitiveness and thus risking a deterioration in the balance of payments and a continued erosion of reserves.8


Real Exchange Rate


Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

8. The balance of payments situation remains precarious. The external current account deficit, at US$279 million (2.0 percent of GDP), was almost unchanged compared to 2000-01, as weak FDI and other financing flows constrained imports. The merchandise trade deficit widened, particularly vis-à-vis Russia and Ukraine, as enterprises in these countries have become more competitive and are no longer so willing to engage in barter (e.g., Belarusian tractors for Russian gas). The trade balance improved relative to non-CIS countries, mainly due to increased exports of oil products. The overall balance of payments recorded a $167 million surplus, mainly because of large capital inflows in December, when the government sold its share in Slavneft and received a disbursement of $40 million from the Russian government earmarked for settling arrears to Russian energy suppliers. Gross official reserves remained at extremely low levels until December, when they rose to $601 million (0.8 months of imports) following the deposit by the government of the privatization proceeds from the sale of Slavneft.9 (Although fragile, the reserves position is bolstered by a 30 percent compulsory surrender requirement on exporters.10) Arrears on Russian gas were flat until late in the year, when commercial banks were pressed to finance repayment of arrears by Beltransgaz. As a result, overall arrears fell by $110 million during 2002, of which $73 million was for gas.

Direction of Trade

(In billions of U.S. dollars)

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Source: Ministry of Statistics.

9. Lower prices for gas supplied by Russia’s Gazprom mask some of the underlying BoP deterioration. Under the terms of an agreement reached in early 2002, Gazprom lowered the price of gas from $29 to about $24 per 1,000 m3. However, Belarus used up the annual quota of gas permitted under this agreement (10.6 billion m3) by early November, and had to pay about $40 per 1,000 cubic meters for additional deliveries through the end of the year. (The value of the implicit subsidy provided to Belarus in this fashion during June-October was about 1.2 percent of contemporaneous GDP.)


External Trade

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001


Export Performance in 2002

(y/y percent change)

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

10. There have been some positive steps in the area of trade policy. The trade regime continues to be rated 8 under the Fund’s trade restrictiveness index. This rating is consistent with an unweighted average tariff of 14.7 percent, combined with (i) export quotas, (ii) export licensing requirements, (iii) export price controls, and (iv) foreign exchange surrender requirements. The weighted average tariff now stands at 9.8 percent. The range of goods subject to export price controls has been reduced modestly. Moreover, 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 a fourth round of negotiations on WTO accession took place in early 2003; the authorities are now working on a checklist of outstanding issues. Belarus is not considered a market economy by a number of major trading partners.

11. The banking sector remains fragile. The foreign asset cover of commercial bank foreign currency deposits has fallen to very low levels (Box 1) and the banking system has incurred net losses in last two years. The six largest banks (five of which are state-owned) have often been forced to lend to priority sectors/enterprises, and may have asset portfolios of dubious quality.11 As a consequence, the government supports these banks through periodic capital injections. Although elimination of directed lending was a condition of the SMP, the largest banks were required to lend to agricultural processing enterprises during the summer, as well as to finance the clearance of enterprise wage arrears and debt to Russian energy suppliers at end-year. The authorities report that the ratio of non-performing to total loans fell from 14.4 percent at end-2001 to 8.3 percent at end-2002. However, given weak corporate profitability, the staff believes that the quality of bank assets may have actually deteriorated during 2002. This worsening in bank assets suggests that currency mismatches may be growing as well.


Reform Progress

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

Source: EBRD Transition Report 2002.Note: Minimum score (little progress) is 1 and maximum score is 4.5 (“4+”) except for the share of private sector, which is re-normalized between 0 and 5. The privatization indicator is an average of the small-scale and large-scale privatization scores.

Financial and Corporate Sector Vulnerability

Financial sector vulnerability indicators tell a mixed story. On paper, capital adequacy seems good and the reported share of non-performing loans is declining. However, corporate sector profitability has been badly affected by administrative wage increases and real appreciation of the rubel, suggesting that bank assets may be rather more impaired than official indicators show. In addition, the high level of dollarization suggests a significant risk of currency mismatches. Continued real increases in commercial bank credit to the economy (80 percent of which consists of state enterprises) and the authorities’ renewed resort to directed credits in mid-2002 suggest that official data on financial sector health should be treated with caution.

Belarus: Selected Financial and Corporate Sector Indicators (2000-02)

(In percent unless otherwise indicated)

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

Books of the major banks are usually audited by local branches of internationally reputable audit companies.

Using the authorities’ definition of required loan loss provisioning.

Domestic loans excluding (net) lending to the government and the NBB.

Fitch ratings for short-term debt of Belarusbank and Priorbank In October 2002, Fitch withdrew the rating for Priorbank.

12. With a few exceptions, structural reforms have largely stalled since 2001. The key exception is the reduction in energy sector cross-subsidization, as utility tariffs and rental payments were increased by an average of 190 percent over the course of the year. Indeed, the authorities have argued that the wage increases in 2001 were needed so that household utility tariffs could be increased in 2002 (Box 2 discusses this assertion).12 Some progress was also achieved in price liberalization, and a recent draft decree would reportedly reduce the number of activities requiring licenses sharply.13

13. The business environment continues to be among the least hospitable in the region. The tax and regulatory regimes are overbearing and—more important—unstable. The economy is still overwhelmingly state-owned, but the authorities are beginning to corporatize firms at a faster rate than in the past, and are moving toward large-scale privatization. In addition to the sale of the Slavneft stake, the Belarusian parliament recently approved the possible privatization of Beltransgaz. Moreover, the authorities are near to completing the corporatization of a number of large petrochemical companies, and have announced terms and conditions for the sale of stakes in five large enterprises in the sector (Box 3). Nevertheless, the regulation permitting the President to introduce the “golden share” in a company after it has been privatized remains in force.14

II. Economic Integration with Russia

14. Prospects for monetary integration of Russia and Belarus are unclear. Although it is not obvious that Russia and Belarus form an optimal currency area, cultural and political affinities between the two states are strong.15 However, it will be very difficult for Belarus to achieve the fiscal and structural adjustment (including labor market flexibility) needed to underpin a hard peg or ruble-ization according to the existing timetable (Box 4).

Wage Policy and Increases in Utility Tariffs

Household utility tariffs were raised sharply in 2002, but from very low levels. Average utility prices grew by 190 percent during 2002, much faster than consumer inflation. While utility payments made up only about 5 percent of consumption expenditures in 2001, they reached 10 percent in 2002, thereby returning to the level of 1995 when the authorities began implementing “socially-oriented” policies. In Russia and Estonia, consumers spend on utilities about 10 percent and 15 percent of their expenditures, respectively.

Tariff hikes have been more than compensated by wage increases. Real wages grew by 31 percent in 2001 and by an additional 8 percent in 2002, compared with GDP growth of less than 5 percent in each year. Based on winter utility rates, the December payment for a two-bedroom apartment occupied by three persons (two of which are wage earners) was about Rbl 56,000 in 2002, up from Rbl 19,000 in 2001 (summer tariffs are around 55 percent of winter tariffs), Nominal wages rose by approximately Rbl 46,000 per person after taxes, suggesting that this household spent about 30 percent of its incremental wage income on utility payments. However, taking into account that some energy prices rose substantially only in November and December, this household actually spent just 15 percent of its incremental after-tax wages on utility payments. Importantly, in 2003 the household will face the higher tariffs for the full year.

A similar conclusion emerges from the analysis of aggregate data. Household money income grew from Rbl 12.5 trillion in 2001 to Rbl 19.2 trillion in 2002. Utility payments rose by estimated Rbl 700 billion last year. Therefore, the population spent on average about 12 percent of their incremental after-tax monetary income on additional utility payments.

The foregoing does not imply that higher tariffs were easy for the poor to bear. However, targeting of social assistance—including means-tested lifeline tariffs—would have been far cheaper than an administrative economy-wide wage hike.


Real Utility Prices

(Jan 2001 = 100)

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

Sources: Ministry of Economy and IMF staff estimates.

Share of Utility Payments in Disposable Income

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

Note: Summer Tariffs in effort during May-September.Sources: Ministry of Economy and IMF staff estimates.

Household Utility Payments

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Note: A household has three members (two wage-earners) living in a two-room apartment.Sources: Ministry of Economy and IMF staff estimates.

Government Plans for Large Scale Privatization in 2003

Relative to other transition countries, progress with privatization has been very slow in Belarus. Over 1500 enterprises were corporatized (transformed into joint stock companies) from 1991 to January 1, 2003, but still only 20 percent of GDP was produced in the private sector in 2001, the lowest share among all transition countries. The authorities count corporatized and partially privatized enterprises in the private sector, meaning the official statistics overstate the private sector contribution to GDP (putting it at almost 50 percent in 2001).

The government has announced plans to auction 43 percent stakes in four petrochemical companies in early 2003: the Naftan oil refinery (with a price floor of USS476 million); the Polimir polymer plant (US$311 million); Grodno Azot, a nitrogen fertilizer manufacturer (US$293 million), and Grodno Khimvolokno, a chemical fiber maker (US$71 million). The winners would acquire (for cash, not barter) 20 percent of shares in 2003, 10 percent in 2004 and the remainder in 2005. The government has placed a number of restrictions on the buyers: they would have to invest an amount equal to the sale price, while maintaining social guarantees and all social infrastructure currently owned by the enterprise, and they may not cut jobs. Some observers have argued that these conditions, and the minimum prices, could discourage potential buyers.

The authorities have also announced plans to corporatize large enterprises in other industries. The government intends to corporatize Beltransgaz by April, and transform it into a Belarusian-Russian joint venture with Gazprom by July. In addition, other firms to be corporatized and privatized include the scientific and production association Integral, the Kirov Automobile Factory in Mogilyov, the glass factory Neman, and the Minsk Computing Equipment Factory.

15. Presidents Lukashenko and Putin have disagreed publicly about political and monetary integration. President Lukashenko—traditionally seen as the one pressing most aggressively for unification—was apparently caught off-guard by President Putin’s offer to accelerate the process in August. Russia proposed that Belarus “ruble-ize’’’ ahead of schedule in 2004, and suggested two options for political integration, depending on the outcome of a referendum in both countries: incorporation of Belarus into the Russian Federation or an approach similar to the European Union. President Lukashenko rejected both options, preferring a vaguely defined “Union State” that ensures continued sovereignty for Belarus.

III. Policy Discussions

A. Overview

16. Responsiveness to Board recommendations has been mixed. In the context of the last consultation, Executive Directors recommended that the authorities refrain from setting unsustainable wage targets, including in foreign currency terms. In practice, the authorities seem to be moving away from setting wage targets in foreign currency terms, but continue to target real wage growth that is based on unrealistic expectations for productivity. Directors also advised the authorities to use the flexibility allowed under the crawling band arrangement to avoid a further erosion in external competitiveness; however, the real appreciation of the rubel has continued. Finally, Directors emphasized the importance of structural reforms, including price liberalization, improving the business environment, and accelerating privatization. Some progress with price liberalization took place, and significant measures were taken with respect to removal of energy sector cross subsidization.

Progress Toward Monetary Unification of Belarus and Russia

Negotiations on monetary union have been protracted. Following a 1999 treaty on creation of a Union State, the authorities in both countries signed a Joint Action Plan on monetary unification (JAP) in June 2002. The JAP envisages a hard peg of the Belarusian rubel to the Russian ruble in 2004 and “ruble-ization” in 2005. In this context, the CBR opened a Rub 4.5 billion credit line to the NBB, conditioned on performance against an agreed financial program. Rub 1.5 billion was disbursed in 2001 (and rolled over in 2002), and the other two tranches were disbursed in 2002. All three tranches fall due in 2003; they could be rolled over again, but there is no agreement on a financial program for 2003.

The JAP also envisages a broad agenda of fiscal and structural measures. Tax law and fiscal policy are to be harmonized with those of Russia by 2004, including elimination of direct NBB credit to government. Trade and customs policy is already largely harmonized, but difficult structural reforms are envisaged in a number of areas.

There is not full agreement about the mechanics of currency unification. Although the NBB acknowledges the need for a “single emission center,” they do not agree that this center should be the CBR. They would prefer to create a new institution to oversee monetary policy for the currency area. Russia categorically rejects this idea, and is adamant that CBR independence not be undermined. In recent press remarks, NBB officials have indicated that, although they plan to peg to the ruble on January 1, 2004, they may postpone currency union for several years.

The NBB is considering conversion to the ruble at an appreciated exchange rate, specifically a purchasing power parity (PPP) rate that is about 40 percent more appreciated than the current market rate. In light of possible real appreciation of the Russian ruble over the medium term, the mission strongly cautioned the NBB against adopting an overvalued conversion rate that would undermine export competitiveness and growth.

17. The 2003 discussions focused on the following: (i) the policy implications of fixing the exchange rate to the Russian ruble on January 1, 2004, and joining a currency union with Russia on January 1, 2005; (ii) macroeconomic policies in 2003 and over the medium-term; (iii) external and domestic vulnerabilities, particularly in the banking sector; and (iv) IMF relations, including forms of technical cooperation.

18. The mission did not take a position on whether or not Belarus should join a currency union with Russia. Rather, it sought to ensure that policymakers understood the implications for fiscal and monetary policies of a peg or a currency union. In this context, the staff argued that the authorities’ projections for 2003 were built on a macroeconomic framework that relies on overoptimistic assumptions for GDP growth, exports, FD1, and money demand. The mission urged the authorities to tighten monetary and fiscal policies to bring inflation closer to the levels expected in Russia (8 percent in 2004), as well as to accelerate structural reforms well ahead of pegging. In particular, the staff expressed concern that direct NBB financing of the budget deficit would continue throughout 2003, and urged the authorities to abstain from directing commercial bank credit to priority sectors or objectives.

19. The Belarusian authorities continue to favor a gradual approach to reform and macroeconomic stabilization. While gradualism might be a feasible (if decidedly less than optimal) approach under normal circumstances in Belarus, the prospect of currency union with Russia makes it a very poor strategy at present. Thus, the mission emphasized the urgency of adjusting macroeconomic policies to underpin the planned exchange rate peg.

B. Outlook for 2003

20. The mission argued that the authorities’ projection of 6-6½ percent growth in 2003 is overoptimistic, noting particularly the fact that key trading partners are expected to grow much more slowly. The mission presented two alternative projections—a baseline (current policies) and a reform scenario, with the latter indicating the size of the adjustment needed to underpin an exchange rate peg on January 1, 2004. Under the staffs baseline scenario, growth would only be 3½ percent.16 Under the reform scenario, real GDP growth would be 2 percent in 2003, given the need for a considerable fiscal and monetary adjustment to bring inflation down and to make the exchange rate peg sustainable. This lower rate of growth is more than compensated over the medium term, however. (See Appendix IV.) The experience of neighboring transition countries suggests that robust economic growth will only begin once macroeconomic stabilization takes root and structural reforms are implemented.

Key Economic Aggregates and Projections, 2001-03

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Sources: Belarusian authorities and IMF staff estimates.

21. The authorities are unwilling to revise macroeconomic policies and objectives for 2003, arguing that to do so would undermine the 2001-05 economic development plan. Specifically, they fear that elimination of direct central bank financing of housing construction in 2003 would cut real GDP growth, and assert that the required fiscal adjustment would be difficult to accomplish without limiting expenditure in politically sensitive areas, such as agriculture, education and health care, where the authorities have announced ambitious targets for increased real spending in 2003-04. The authorities do not seem fully convinced of the need to harmonize macroeconomic policies with those of Russia before pegging the exchange rate.

C. Fiscal and Monetary Policies

22. The mission argued that—on current policies—inflation during 2003 is likely to be 27 percent, well above the authorities’ target (18 percent-24 percent) and the target in Russia (10 percent-12 percent). The authorities argue that the remonetization of the economy and accommodation of the inflation objective will require rubel reserve money growth of 38 percent (and the resulting rubel broad money growth of 35 percent).

23. The staff proposed a considerably lower expansion in reserve money to bring inflation to 17 percent by end-2003, the level required to ensure that Belarusian inflation in Q4 is approximately in line with that of Russia. Under this reform scenario, rubel reserve money growth would have to be about 15 percent, primarily by limiting NBB credit to government. Rubel broad money growth would likely be about 25 percent, in line with a growth in banking system credit to the economy of about 21 percent.


Russia and Belarus: 12-month Inflation

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

24. The mission emphasized that an exchange rate peg would not be durable without supportive fiscal policies. The authorities project a significant increase in VAT receipts in their 2003 budget, and an even larger increase in payroll tax contributions to the SPF. The mission expects revenue performance in 2003 to be broadly similar to that of 2002, while expenditure commitments in the budget are up sharply.17 In order to support the peg, the mission proposed an adjustment in the budget deficit of about 4 percent of GDP (commitment basis), relative to the baseline scenario.

25. In the staffs view, most of this adjustment should come on the expenditure side, given the already high tax burden in Belarus. The mission stressed that, instead of large cuts in social spending, the adjustment should be focused on reducing subsidies to agriculture, and scaling back the housing construction program, road construction, and budgetary lending. Targeting of social assistance should be improved.18 In this context, staff encouraged the authorities to implement as rapidly as possible the key recommendations of the World Bank Public Expenditure Review.

D. Exchange Rate Policy

26. The mission argued that the rubel is currently overvalued. Since September 2001, the real effective exchange rate has risen by 10 percent. Indeed, over the past two years real wages have grown by about 42 percent while productivity growth was only 12 percent. Restoring competitiveness at this stage is particularly important in light of plans to peg the rubel to the ruble on January 1, 2004. Once pegged, the rubel would be expected to remain so until a currency union is in place, and it is certainly possible that the Russian ruble will appreciate in real terms over the medium term, exacerbating the effect of any misalignment at the time of the pegging.


Trade Balance and Real Exchange Rate

Citation: IMF Staff Country Reports 2003, 117; 10.5089/9781451805079.002.A001

27. The mission urged the authorities to aim for some real depreciation of the rubel in order to restore competitiveness lost over the past 18 months. This could be achieved by holding to the pre-announced nominal crawling band for 2003, while implementing policies geared at reducing inflation to the target proposed under the reform scenario. The authorities were not uniformly persuaded that the external competitiveness lost over the past two years needs to be restored.

28. There was more agreement, however, on the need to reorient the exchange rate regime itself. Although the de jure target of the exchange rate crawling band regime is the Russian ruble, de facto the authorities target the U.S. dollar. About 60 percent of Belarusian trade is with Russia and the two economies are highly integrated. Moreover, the two countries have signed an interstate agreement envisaging currency union in less than two years. The authorities indicated that they agree with the need to bring the de facto regime in line with the de jure regime.

E. Structural Policies

29. The mission noted that while supportive monetary and fiscal policies are necessary for a pegged exchange rate to be sustainable, they are not sufficient. Staff argued that deep structural reforms are needed to help the Belarusian economy adjust over time to changing international conditions, including the expected increase in energy prices. Labor markets need to become much more flexible, including by streamlining the existing administratively determined wage tariff classifications, and by allowing enterprises to lay off redundant workers in order to improve productivity. The authorities agree that structural reforms are needed, but are constrained by the need to support well publicized social objectives. Nevertheless, the authorities seem to have abandoned the practice of targeting average wages in dollar terms, but are reluctant to announce this change to the public.

30. The mission and the authorities broadly agree on the need to improve the environment for private business in Belarus. The chief barriers to private sector activity seem to be (i) the unstable legal and administrative framework; (ii) the excessive—and again unstable—tax burden; and (iii) the pervasive culture of state intervention and inspections. Thus, for instance, the mission urged the authorities to streamline the licensing regime substantially, and a long-awaited presidential decree doing so is expected to be issued shortly. Over the medium term, however, these measures will not be effective unless supported by an effective civil service reform.

31. Privatization is essential to stimulate investment and to make the enterprise sector more market oriented. The staff argued that it would be particularly important to ensure that the privatization process be transparent and competitive, and suggested that this outcome would be facilitated by employing internationally recognized consultants to advise in this process. The mission advised that large government holdings, including Beltransgaz, be subjected to an independent audit by an internationally-reputable firm before their privatization (including through any debt-equity swap for gas arrears).19 The staff welcomed progress with corporatization, and encouraged the authorities to complete the process of administratively separating enterprises from branch ministries. The mission urged that small scale privatization be accelerated, and recommended elimination of the decree allowing the president to issue a golden share after a firm has been privatized. The authorities recognize the need to address these concerns, and are preparing draft legislation that would make it impossible to issue the golden share in a firm unless that had been foreseen at the time of incorporation.

A Privatization Fund for Belarus?

Several developing and transition countries have set up privatization funds to ensure prudent and transparent use of privatization proceeds, and therefore public support for large scale privatizations. The mission discussed the possibility of creating a privatization fund in Belarus, possibly geared to financing key structural reforms, such as that of the pension system.

Establishing a successful privatization fund Privatization funds have been established to mitigate the volatility and unpredictability of privatization proceeds (“stabilization” funds) as well as to save part of the revenues for future generations, for example for financing pension reforms (“savings” funds).

They are not uncontroversial, however. Some analysts believe the creation of privatization funds poses a danger to the integrity of the budget process. Accordingly, best practices for the management of privatization proceeds would seem to include the following:

  • The privatization fund should be an integral part of the budget; placing it off-budget tends to limit control and reduce transparency in recording and use of revenues.

  • Strict and transparent audit guidelines and rules for fund management are needed, with clear oversight arrangements involving parliament.

  • To ensure transparency, privatization transactions should be recorded on gross basis, with privatization-related expenditures (such as debt relief by the government) listed explicitly.

  • Privatization is a transfer of assets, and proceeds from it should be treated as financing item in the fiscal accounts.

Experience of Lithuania While not without setbacks, the overall progress with privatization in Lithuania has been good. Between 1991 and 2002, the share of the private sector in GDP increased from 10 percent to 75 percent-80 percent. A privatization fund (PF) was established in 1995. In 2000 the PF was incorporated in the budget and is administered according to the best practices above. PF resources may be used for stabilization purposes and could in the future contribute to financing the pension reform.

Lithuania: Privatization Fund

(in percent of GDP)

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In addition to establishment of the privatization fund, other factors contributed to the success of privatization and attraction of foreign investment in the late 1990s: offering majority stakes in state owned enterprises (including in strategic industries such as telecommunications, energy, transport); creation of a sole agency in charge of management and privatization of the state property; and use of independent, reputable consultants—especially when privatizing “strategic enterprises.”

32. The mission urged faster efforts to reform the agriculture sector. The authorities are very concerned about the colossal sums being channeled into agriculture (including through preferential taxes), and the president has pushed for reforms to make the sector more efficient. In this regard, the mission welcomed efforts to corporatize state farms (sovkhozy), while stressing that a more comprehensive reform program was needed. The authorities seem to agree with this diagnosis, but are uncertain about how to accomplish the task.

33. Much has been done to eliminate energy sector cross subsidization and to improve cost recovery. In particular, the mission welcomed the very significant increase in cost recovery ratios (from below 30 percent in early 2002 to 60 percent in early 2003). But increases in cost recovery need to go further, and the authorities are well aware that the Belarusian energy sector is still in need of significant reform (including by creating appropriately independent regulatory bodies). The authorities see that pressure to address institutional weaknesses in the energy sector will grow as WTO accession draws nearer.

34. The mission urged the authorities to take early action to address financial sector vulnerabilities, particularly in the run up to currency union with Russia. A long term solution needs to go hand in hand with reform of the corporate sector itself, including through privatization.20 However, in the short run the mission noted that the authorities should move to tighten prudential regulations, including by (i) seeking to limit lending in foreign currency (to firms with identifiable and adequate sources of foreign currency income), (ii) guarding against bad loans stemming from political pressure; (iii) ceasing the practice of providing loans at preferential interest rates, and (iv) avoiding distress borrowing when firms seek to meet administrative targets, including to clear wage arrears. In particular, the mission urged that directed credits in all forms should once again be eliminated. The authorities seem concerned about the health of the banking sector, and have pressed for an early FSAP.

F. IMF Relations and Data Issues

35. The authorities would like the Fund to support their program through a stand-by arrangement, and believe that it would be appropriate to move at this time to negotiations on an SBA. They argue that a new SMP or analogous track record period is not necessary because performance under the 2001 SMP was adequate. In contrast, the staff considers that performance under the 2001 SMP was disappointing, particularly in the fiscal area, where the deficit exceeded the program target by 60 percent. More importantly, the mission and the authorities disagree sharply about the appropriate stance of fiscal and monetary policies going forward. The staff believes that a sustained period of successful macroeconomic policy performance—preferably in the form of an SMP—continues to be merited.

36. The authorities have shown strong interest in expanding technical cooperation with the Fund. Indeed, Belarus has a good record of implementing TA. An FAD tax policy mission advised on the draft tax code in March, and a fiscal ROSC mission will review the budget system in late April. An MAE mission consulted with the Belarusian and Russian authorities on technical aspects of setting up a currency union in early April.21

37. Some key macroeconomic indicators continue to be compiled using outdated methodology, despite the authorities’ generally good record of production and dissemination of statistical data (Appendix III). The mission urged the authorities to adopt a new methodology for compiling the industrial production index that was developed with assistance from STA, as this would reduce overestimation of GDP in official statistics. However, the authorities continue to argue that the socio-economic development plan for 2001-05 (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 is still not possible under the new methodology.

38. The authorities are close to seeking subscription to SDDS. They have drafted and posted on their web sites SDDS-like metadata templates, publish data release calendars, and disseminate most data with a frequency and timeliness close to that recommended by the SDDS.

39. The mission discussed with the authorities their response to the AML/CFT questionnaire. Although Belarus has not established a full-fledged and internationally recognized Financial Intelligence Unit, they are in the process of implementing the key 1999 and 2000 UN Conventions, and seem to be implementing UN Security Council Resolution 1373. The authorities are considering requesting assistance from the Fund on drafting new AML legislation.

IV. Medium-Term Outlook and the Balance of Payments

40. To illustrate medium-term prospects, the staff prepared and discussed with the authorities two scenarios for the period to 2008 (Appendix IV). Both scenarios assume the same external economic conditions, as well as a fixed peg of the Belarusian rubel to the Russian ruble starting January 1, 2004.

41. Staff medium-term projections highlight the urgency of macroeconomic adjustment. Under the baseline (current policies) scenario, medium-term balance of payments prospects are clouded by low competitiveness and external financing constraints. The initial exchange rate overvaluation—along with insufficient enterprise restructuring, high labor costs, and administrative obstacles to exports—contributes to further losses in competitiveness, and leads to stagnant growth caused by import compression (and possibly a modest build-up of external arrears and debt contracted on commercial terms). Under the reform scenario, the stance of monetary and fiscal policy is tightened significantly in 2003, and the share of government in the economy is gradually brought down to levels closer those in Russia. Growth would be expected to rebound strongly under this scenario.

42. 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 share of short-term debt and arrears. Assuming that privatization transactions are carried out in a carefully-prepared, transparent and competitive manner, relatively little FDI or external financing is likely to be forthcoming in 2003. The authorities are confident that these privatizations will be attractive to investors, and thus have more optimistic projections regarding FDI. 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

43. Over the past two years, the Belarusian authorities have made noticeable improvements in a number of areas. In the energy sector, cross-subsidization has been reduced and cost recovery has greatly increased, while the scope of price liberalization has expanded and a new provision streamlines the registration of small enterprises. A crisis in the pension system was averted last year through strong and unpopular measures, and inflation continues the gradual decline of previous years.

44. However, Belarus continues to have the highest inflation in the CIS. This outcome stems from weak macroeconomic policies and has contributed to a loss of external competitiveness. The financial system is fragile, and in this regard it is particularly regrettable that directed credits have reappeared, as their elimination was a key achievement of the 2001 SMP.

45. The authorities’ projections for 2003 are both overoptimistic and insufficiently ambitious. Their real GDP growth targets are well in excess of those in major trading partners, and they project levels of foreign direct investment that do not seem plausible. Moreover, the current pace of disinflation is not consistent with the planned pegging of the exchange rate to the Russian ruble on January 1, 2004.

46. Exchange rate policy and the exchange rate regime itself—particularly in light of the relations envisaged with Russia—are the key challenges facing the authorities at the present time. The choice of whether and when to peg to the Russian ruble and then to “ruble-ize” is fundamentally a political decision the Belarusian authorities will have to make. But either decision has economic consequences, and it will be important for the authorities to ensure that macroeconomic policies are consistent with the exchange rate regime they settle upon, and that the level of the exchange rate is appropriately competitive.

47. The Belarusian rubel is somewhat overvalued at present. Competitiveness lost through the real appreciation that has taken place over the past 18 months has impacted corporate profitability and led to tax and wage arrears. The urgency of taking action to restore competitiveness is heightened by the fact that in less than a year the rubel is likely to be pegged to the Russian ruble, a currency that—as a result of expected gains in productivity—could be marked by substantial real appreciation over the medium term.

48. Monetary policy needs to be tightened in order to bring inflation down at a faster pace than currently envisaged by the authorities—even if they were to decide not to peg the exchange rate. However, in light of the proposed peg, it is essential to reduce inflation to near Russian levels by the end of this year. Indeed, if monetary and fiscal policies are not tightened at this stage and the rubel continues to appreciate in real terms, the 2004 peg could cause the same social disruptions the authorities have sought to avoid through gradualism in the 1990s.

49. Tighter monetary policy and the need to regain competitiveness should be supported by significant fiscal adjustment. The adjustment should come on the expenditure side, given the already high tax burden in Belarus. With general government expenditure at nearly 50 percent of GDP, the necessary expenditure adjustments appear feasible without disproportionate cuts in social spending. Areas for such reductions include: subsidies to agriculture; the housing construction program; road construction, where a more cautious approach could be taken; and budgetary lending. Holding Social Protection Fund expenditures as a share of GDP to about the level of 2002 would generate savings relative to the 2003 budget.

50. Deep structural reforms would also be needed to raise productivity and support the exchange rate. Chief among these reforms would be efforts to make the labor market more flexible, particularly by allowing state enterprises to lay off redundant workers. Wage policy should reflect growth in labor productivity, while the target of $250/month by 2005—which is formally still in place—remains unrealistic and would contribute to lower growth and higher unemployment.

51. It is essential to improve the environment for private business in Belarus. The chief barriers to private sector activity seem to be (i) the unstable legal and administrative framework; (ii) the excessive—and again unstable—tax burden; and (iii) the pervasive culture of state intervention and inspections. Businesses will not invest if they cannot plan on a stable environment, and excessive state inspections create tremendous potential for corruption, and thereby raise the cost of doing business. Thus, there is a need to streamline the licensing regime substantially.

52. Privatization would stimulate investment and make the enterprise sector more market-oriented. It is particularly important to ensure that the privatization process be transparent and competitive, an outcome that would be facilitated by employing internationally recognized consultants to advise in the process. Progress with corporatization is long overdue, and the authorities are encouraged to complete the process and to wean public enterprises from state subsidies. The authorities are urged to eliminate the golden share in its current form, as this would encourage foreign direct investment in Belarus. Finally, small scale privatization should be accelerated.

53. Early action is needed to address vulnerabilities in the financial sector. The importance of doing so quickly is heightened by the possibility that tighter monetary policy could exacerbate weaknesses in the banks. In the short run, prudential regulations should be tightened and directed lending needs to be avoided. Looking to the future, the authorities are encouraged to initiate preparation of a comprehensive program to restructure the financial and corporate sectors. Piecemeal privatization and ad hoc bank recapitalization will not solve the deep-seated problems of the Belarusian real and banking sectors. A comprehensive reform program, drawn up with assistance from the IFIs and the international community more broadly, could provide a useful roadmap for guiding the difficult reforms that lie ahead.

54. A sustained period of positive macroeconomic performance continues to be merited before negotiations on a stand-by arrangement (SBA) could begin. Performance under the 2001 SMP was not entirely satisfactory, and the authorities need to change macroeconomic policies decisively in a way that is consistent with the proposals noted above. In the staffs view, a successful track record period (with appropriate prior actions) of at least three quarters—preferably in the context of an SMP—would be essential prior to the use of Fund resources by Belarus.

55. The mission strongly supports expansion of technical assistance and related forms of collaboration with Belarus. The emphasis on expanding technical collaboration seems appropriate in this case, given that Belarus has a good record of implementing IMF technical assistance recommendations. Although there are some weaknesses, the quality of data provision is generally adequate for surveillance purposes. The Belarusian authorities are particularly encouraged to apply for subscription to the IMF’s Special Data Dissemination Standard.

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

Table 1.

Belarus: Selected Economic Indicators, 1999-2003

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Sources: Belarusian authorities; and Fund staff estimates.

As of March 2003.

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

Consolidates the state government and Social Protection Fund budgets.

Flow during year. Includes revaluation of net lending in foreign currency. For the authorities’ projection for 2003, in domestic currency only.

Rubel reserve money.

Since November 21, 2002.

Based on NBB balance sheet data.

Table 2.

Belarus: Fiscal Indicators and Projections, 1999-2003

(In billions of rubels, unless otherwise indicated)

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Source: Ministry of Finance, SPF, and IMF staff estimates.

Includes changes in expenditure arrears.

The actual deficits for 1999-2001 from above the line include all the closing expenditure for the year carried out in January of the following year and correspond to the authorities fiscal year reports. The deficit values from the financing side include January closing expenditure in the year they were actually paid. For 2002 the deficit above the line excludes closing operations.

Table 3.

Belarus: Fiscal Indicators and Projections, 1999-2003

(In percent of GDP, unless otherwise indicated)

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Source: Ministry of Finance, SPF, and IMF staff estimates.

Includes changes in expenditure arrears.

The actual deficits for 1999-2001 from above the line include all the closing expenditure for the year carried out in January of the following year and correspond to the authorities fiscal year reports. The deficit values from the financing side include January closing expenditure in the year they were actually paid. For 2002 the deficit above the line excludes closing operations.

Table 4.

Belarus; Monetary Accounts, 2001-03 (Baseline scenario)

(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 the NBB as of January 1, 2002.

Numbers for 2001 are based on the old chart of accounts of the NBB; the changes in the chart of accounts led to a break in the time series.

Defined as annual GDP divided by average broad (rubel broad) money for the year.