This Selected Issues paper reviews developments during 2001–02 in the Belarusian pension system, and discusses potential short- and medium-term reforms needed to put pension system finances on a sustainable path. The paper presents a short overview of demographic trends and developments in Belarus and their impact on the pension system. It discusses the financial difficulties of early 2002 and the policy measures the authorities took to deal with them. A critical review of the methodology used in preparing annual Social Protection Fund budgets is also presented.

Abstract

This Selected Issues paper reviews developments during 2001–02 in the Belarusian pension system, and discusses potential short- and medium-term reforms needed to put pension system finances on a sustainable path. The paper presents a short overview of demographic trends and developments in Belarus and their impact on the pension system. It discusses the financial difficulties of early 2002 and the policy measures the authorities took to deal with them. A critical review of the methodology used in preparing annual Social Protection Fund budgets is also presented.

IV. Belarus-Russia Union: Progress Report1

Executive Summary

This chapter updates a paper prepared for the 2001 Article IV consultation.2 Bilateral relations with Russia are particularly important in Belarus, given the historically strong cultural and economic ties between the two countries, and there have been a number of important developments over the past year. In particular, agreement was reached on an action plan to guide introduction of the Russian ruble in Belarus, and in this context the Belarusian authorities implemented a monetary program agreed with the Central Bank of Russia (CBR). There were significant agreements in the area of gas and transport pricing, and some important political issues related to the future of the Union State were discussed. Formally, the Belarusian rubel (Rbl) is to be pegged to the Russian ruble (Rub) on January 1, 2004, and monetary unification (with the ruble replacing the rubel) is meant to occur on January 1, 2005. A new currency for the Union State could replace the ruble in 2008. However, at this stage the prospects for monetary union are uncertain.

A. Review of Developments on Monetary Union

1. Negotiations over monetary union have been protracted. Discussions on a union of Belarus and Russia began in 1994, not long after the break-up of the Soviet Union. These negotiations reached an important stage in 1999 when agreement was reached on creation of a Union State. Traditionally, the Belarusians have been seen as being more interested in reunification than the Russians, and a portion of President Lukashenko’s popularity in Belarus has derived from strong advocacy of this process.

2. Economic ties between the two countries are strong. In addition to close cultural and linguistic ties, the two economies are highly integrated. Over 60 percent of Belarusian trade turnover is with Russia (53 percent of exports and 65 percent of imports of goods and services in 2001).3 Russian exports to Belarus are dominated by gas and oil, with much of the later being processed for export to markets in Central and Western Europe. Belarusian exports to Russia are predominantly machinery, agricultural products and especially transportation services. The Druzhba oil pipeline runs through Belarus, and Gazprom ships a considerable portion of gas exports to Central and Western Europe through pipelines on Belarusian territory. A large, nearly-completed gas pipeline originating in Yamal in Siberia extends across Belarus as well.

3. From the standpoint of theory, Russia and Belarus may not be an optimal currency area. External shocks seem to affect the two countries asymmetrically. While higher energy prices improve the Russian external position, they generally worsen that of Belarus, as the latter produces neither crude oil nor gas. On the other hand, a considerable portion of the oil processing capacity of the former Soviet Union is located in Belarus, suggesting that the impact of oil price shocks may be mitigated by access to inputs at close to Russian domestic prices. Adverse weather affects Belarus more than Russia, given relatively greater importance of agriculture in Belarusian output. However, the work of Mundell (1961) notwithstanding, the decision to form a monetary union is a largely political one. In the case of Belarus and Russia, a political decision has been taken to move to a common currency.

B. Recent Developments

4. Several important developments relating to monetary union occurred in 2002. A concrete program of economic reforms for Belarus was drawn up by officials in both countries, and disbursements against a CBR stabilization loan and an export credit line from the Russian Ministry of Finance were made in this context. There were also signs of political disagreement, though by end-year a rapprochement of sorts seemed to have been worked out.

Joint Action Plan

5. An important agreement was signed by officials from both governments and central banks in June 2002. A key objective of this Joint Action Plan (JAP) on introduction of single monetary unit during 2001-05 is to level the playing field for enterprises in both countries. It contains dozens of time-bound measures in the areas of monetary and fiscal policies and structural reforms. Most of the measures envisage obligations of the Belarusian authorities, but Russia accepted a number of important obligations as well.

6. On the basis of the JAP, Belarus agreed to eliminate many tax preferences for domestic enterprises. This was a key Russian requirement, and it was implemented during the summer. Another important Russian objective was to establish a joint venture for gas transit and distribution, with contributions from Gazprom and the Belarusian state gas transit concern, Beltransgaz.

7. The main Belarusian achievement in the JAP was Russia’s agreement to provide gas and transportation services to Belarusian firms at internal Russian prices. For natural gas, this meant lowering the price of gas (as well as electricity) imported from Russia to that of the Russian “fifth energy belt” (e.g., to the prices paid in nearby Smolensk oblast). Again, the objective was to level the playing field for Belarusian and Russian firms throughout the union. In practice, it meant that Gazprom reduced the price of gas at the border to $24 per thousand cubic meters (tcm) from the previous price of $31/tcm. The agreed volume of sales during 2002 by Gazprom was 10.6 billion cubic meters (bcm). It is not clear how seriously the Belarusian authorities took the agreed volume limit, but late in the year it became clear that Gazprom—which reportedly receives about $80/tcm for gas sold to Poland and Lithuania and $60/tcm for that sold to Ukraine—took it very seriously.4 (See below.)

8. There were two disbursements in 2002 of a stabilization loan from the CBR to the NBB. The overall size of this loan was Rub 4.5 billion, and it was disbursed in three equal tranches with a one year maturity, beginning in July 2001. The first tranche was rolled over in July 2002, following disbursement of the second tranche in June. The third tranche was released in November. Disbursements under this loan were conditioned on performance against an agreed monetary program for first nine months of 2002.

9. The CBR monetary program bore a similarity to the 2001 SMP. It contained quantitative targets on the usual variables; there was a ceiling on NDA, a floor on NIR, an indicative target for reserve money growth, and adjusters to allow for unplanned inflows. Performance under the program was monitored by the Interbank Currency Council (ICC), which comprises the heads of the two central banks and representatives of their senior staffs. The final test date under this program was September 30, 2002, on the basis of which the third tranche was released in November. The lack of external constraints in form of a quantitative framework may explain the weakening of monetary policy in the fourth quarter of 2002. (During the 2001 the SMP also ended with the third quarter.)

10. The JAP also provided a framework for an export credit from the Russian Ministry of Finance (MoF) to the Belarusian MoF in late December 2002. This US$40 million loan—earmarked for purchase of Russian products (chiefly gas)—was conditioned on the following:5 (i) raising export duties on oil and oil products to Russian levels, (ii) containing the budget deficit to 1.5 percent of GDP, (iii) moving toward competitive procedures for state procurement, (iv) eliminating directed credits through the banking system, and (v) moving refinance of commercial banks to a competitive basis. The terms of the loan were preferential (LIBOR plus 0.75, with principal to be repaid in three annual installments following a three-year grace period).

11. A number of structural measures are also envisaged in the JAP. In addition to unification of the external trade policy regime and issues related to monetary unification, these measures include the following commitments by the Belarusian authorities:

  • harmonization of tax and budgetary legislation with those of Russia;6

  • elimination of subsidies for industry;

  • full consolidation of extrabudgetary funds into the state budget;

  • procurement reform;

  • improving the treasury system, including commitment control and limits on energy usage by budgetary organizations;

  • elimination of direct NBB credit to the budget;

  • harmonization of legislation on regulation of natural monopolies and utilities;

  • creation of a joint venture to manage transit of gas across Belarus and distribution of gas within it;7

  • harmonization of legislation concerning the licensing regime for business activities, bankruptcy and anti-money laundering;

  • completion of small scale privatization and harmonization of legislation for large scale privatization; and

  • harmonization of legislation on the insurance market.

A joint committee, headed by deputy economy ministers on each side, is charged with monitoring the structural reform program.

Russian proposal

12. In mid-2002, President Putin surprised the Belarusian leadership—and observers—by proposing to accelerate the process of monetary and political unification. He suggested advancing the date for introduction of the Russian ruble in Belarus by one year, to January 1, 2004, following a referendum to be held in both countries on two possible options for political integration:

  • Incorporation of the seven Belarusian oblasts into the Russian Federation; or.

  • Political unification along the lines of the European Union (where both countries would retain sovereignty subject to something like a subsidiarity principle).

13. President Lukashenko rejected both options. He preferred the status quo, which is the eventual creation of a Union State under which Belarus would retain an unspecified amount of autonomy. Negotiations have continued on drafts of a Constitutional Act for the Union State, but thus far have been inconclusive. At the same time, the NBB agreed to an acceleration of monetary union, but only if the structural preparations envisaged in the JAP had been accomplished beforehand.8 As these may take some time, it would seem unlikely for monetary unification to take place faster than envisaged in the original schedule.

14. A further conflict arose early in the fourth quarter over gas deliveries. The lower gas prices envisaged under the JAP applied only to 10.6 bcm, compared with total imports of about 17 bcm. By November, Belarus had imported the full amount envisaged under the agreement, and Gazprom refused to deliver more than this amount at the low domestic Russian price. Following difficult negotiations, Belarus was obliged to contract with Itera and other commercial suppliers for deliveries over the remainder of the year at significantly higher prices.9

15. Relations normalized late in the year. Some observers have speculated that relations improved when the Belarusian parliament passed a law permitting privatization of Beltransgaz.10 (This step was seen as a crucial precursor to establishment of the Russian-Belarusian joint venture envisaged in the JAP.)

16. However, it remains unclear whether the agreed timetable for monetary union will be adhered to. The Belarusian authorities have noted that introduction of the ruble in Belarus will only take place once the structural reforms in the JAP have been accomplished. Perhaps more importantly, fiscal and monetary policies in 2003 do not seem likely to be consistent with those of Russia by January 1, 2004, at which point the rubel is meant to be pegged to the ruble.11

Outstanding issues

17. Both sides agree that there must be only one monetary “emission center,” but they disagree about the form it should take. While there is some agreement on how to handle the conversion of rubel balances to Russian rubles, the CBR and the NBB have disagreed on the institutional arrangements for managing monetary policy on a day-to-day basis. The Belarusian authorities propose that the ICC—the co-chairmen of which are the two central bank governors—set monetary policy for the new ruble zone, subject to oversight from heads of the Union State. In their view, each central bank would “emit” reserve money according to precise limits set by the ICC12. Russia, by contrast, insists that the CBR be the sole source of ruble reserve money expansion, arguing that the experience of the former USSR and the former Yugoslavia provides a clear example of how a system of multiple central banks can go awry. Although some progress has been made on technical issues like harmonization of prudential regulations, there has not been much discussion about rules for sharing seignorage.

18. There is partial agreement about resolution of the problem of VAT rebates for Russian value added exported through Belarus. Taxation of most CIS trade is conducted on the destination basis, rather than the origin basis.13 However, the Russian authorities have insisted that bilateral trade between the two countries remain on the origin principle, arguing that the open border makes the destination principle unworkable. Because Belarusian firms process considerable quantities of Russian oil for export to markets to the west, the authorities in Belarus have complained they may be forced to provide export rebates for value added originating in Russia. Russian officials recognize that this could be a problem, and have proposed a rule of thumb to guide compensation. The Russian finance ministry would transfer to the Belarusian budget an amount equal to 16.67 percent of the bilateral trade balance, net of gas imports. This amount, which will be in the neighborhood of $ 150-200 million each year, would only be paid once the Russian ruble has been introduced in Belarus (with retroactive compensation to 2003).

19. Apart from the VAT compensation mechanism, there has been little discussion of fiscal federal transfers within the monetary union. The absence of a formal mechanism could be important over the medium term, however. It is possible that the Russian ruble will appreciate in real terms in the coming years, owing to faster productivity growth (as reforms were initiated in Russia well before Belarus) and inflows related to raw materials exports. Moreover, the lack of a formal compensation mechanism makes the rate at which rubel balances are converted to the Russian ruble especially important. Any initial overvaluation of the rubel in real terms relative to the ruble could only be accommodated through painful adjustment in the real sector of the Belarusian economy.

C. Conclusion

20. There has been considerable movement toward establishing a monetary union between Belarus and Russia during 2002 and early 2003. Macroeconomic policies are now closer to being synchronized, though there is still a significant spread between inflation rates in the two countries. Structural reform policies in a number of areas are meant to be harmonized, in many cases leading to significant improvements in institutions and the business environment in Belarus. However, monetary union remains fundamentally a political issue, and it is as yet unclear how quickly the process will advance over the period ahead.

References

  • Dodsworth, J., P. Mafhieu, and C. Shielis, 2002, “Cross-Border Issues in Energy Trade in the CIS Countries,IMF Policy Discussion Paper No. 02/13 (Washington: International Monetary Fund).

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  • Ebrill, L., M. Keen, J-P. Bodin, V. Summers, 2001, The Modern VAT (Washington: International Monetary Fund).

  • Mundell, R., 1961, “The Theory of Optimum Currency Areas,American Economic Review, Vol. 51, No. 4, pp. 65765.

  • Romanchuk, la., 2003, “Nado chashche vstrechat’sia,Belorusskaia gazeta, No. 2 (January 20, 2003).

  • Tarakhovich, A., 2002, “Ne piadi nazad,Belorusskii rynok, No. 34, (September 2-8, 2002).

  • Vlaskin, lu., 2002, “Tsentr pritiazheniia, a ne diktata,Soiuz Belarus’—Rossiia, (September 12, 2002), p. II.

1

Prepared by Thomas Richardson

2

Chapter V of SM/02/9 (01/04/02), pp. 47-57.

3

However, only 5.6 percent of Russian trade turnover is with Belarus, reflecting the relative size of the two countries.

4

See Dodsworth, Mathieu, and Shiells (2002) for a review of energy trade issues in the CIS.

5

The December 2002 tranche was immediately allocated to settlement of arrears on gas deliveries from Gazpronx

6

The Belarusian authorities plan to develop a draft Budget Code based on the Russian code during 2003.

7

The Belarusian side also agreed to clear all debt owed by Beltransgaz to Gazprom.

9

Gazprom has agreed to supply 10.6 bcm during 2003 as well, at a domestic Russian price of $28/tcm. The authorities are negotiating for additional deliveries from commercial suppliers.

11

There is some agreement on Belarusian monetary and fiscal policy in 2004 and beyond. For example, Belarus has agreed to eliminate direct NBB financing of the government budget deficit from January 2004. (These credits are now earmarked for housing construction.)

13

See Chapter 17 of Ebrill and others (2001). Russia remains on the origin principle in energy trade in the CIS for the time being.