Republic of Belarus: Staff Report for the 2004 Article IV Consultation

This 2004 Article IV Consultation highlights that macroeconomic developments in Belarus in 2003 were mixed. Although in real terms GDP, industrial production, and agriculture all grew by 6.8 percent; according to official data prepared on Belarusian national methodology growth, would be lower on international methodology. Fiscal policy was fairly tight during 2003, mainly owing to limited sources of available financing, such as privatization proceeds. The outlook for 2004 is uncertain. Under current policies, inflation is expected to reach about 22 percent, and real GDP growth is likely to slow to about 4¾ percent.

Abstract

This 2004 Article IV Consultation highlights that macroeconomic developments in Belarus in 2003 were mixed. Although in real terms GDP, industrial production, and agriculture all grew by 6.8 percent; according to official data prepared on Belarusian national methodology growth, would be lower on international methodology. Fiscal policy was fairly tight during 2003, mainly owing to limited sources of available financing, such as privatization proceeds. The outlook for 2004 is uncertain. Under current policies, inflation is expected to reach about 22 percent, and real GDP growth is likely to slow to about 4¾ percent.

I. Background and Recent Developments

1. President Lukashenko continues to dominate political life in Belarus. Under the constitution, he would not be allowed to serve beyond his current term, which extends to 2006. However, the opposition seems weak and the president is reportedly preparing a referendum amending the constitution such that he could run for a third term.

2. Macroeconomic performance in 2003 was mixed. Driven by consumption and public investment (especially on housing construction), officially reported real GDP grew by about 6¾ percent in 2003, as did industrial production and agricultural output.1 However, there are growing concerns about the reliability of national accounts statistics, in addition to persistent methodological differences with international practice.2 Rosy macroeconomic data notwithstanding, the financial situation of the enterprise sector continues to be very difficult, as indicated by high inventory levels and the fact that almost half of industry (and two thirds of agriculture) are reporting losses.

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Breakdown of Demand Growth

(Percent contribution)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

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GDP and Industrial Output Growth

(y/y percent change)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

3. Although headline inflation continued to decline gradually, core inflation began to creep up during the second half of 2003.3 As monetary policy loosened, the authorities employed administrative measures late in the year—including slower increases in utilities prices and a narrowing of retail trade mark-ups—to limit the headline figure. Real wage growth fell from about 8 percent in 2002 to 3 percent in 2003.

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Money Growth and Inflation

(m/m percent change)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

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Inflation Dynamics

(In percent, 12-m price change)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

1/ Median core inflation

4. The authorities have constrained fiscal deficits to available financing. During 2003, the general government cash deficit was only 1¼ percent of GDP (1 percent on a commitment basis), reflecting disappointing privatization receipts as well as limited access to external financing. Revenue was supported by buoyant property taxes and customs duties, while profit taxes underperformed (the latter reflecting the deteriorating financial condition of enterprises). Budgetary outlays on agriculture picked up, as the authorities sought to compensate for losses in the farm sector. Quasi-fiscal activities remained significant, including widespread directed lending to state enterprises, for investment and also for clearance of tax and wage arrears.4 The staff has no information on resources under the control of the administrative department of the presidential administration.

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CIS: General Government Fiscal Balance

(Cash, in percent of GDP)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

Source: IFS, International Monetary Fund

5. The balance of payments situation remains difficult. The current account recorded a deficit of about 2.6 percent of GDP in 2003, about the same as in 2002, and the merchandise trade deficit remained at 6.2 percent of GDP. Trade turnover rose very sharply on high energy prices, as demand for oil products exports—and thus crude oil imports—was high. (A significant portion of the USSR’s oil processing capacity was located in Belarus.) Nevertheless, the energy prices Belarus faces (particularly for natural gas) rose on average by about 20 percent in 2003.5 FDI was low as privatization stalled, but high interest rates attracted some short-term capital from Russia. Gross international reserves jumped in late 2002 (following a large privatization sale), but since then have remained at about ½ month of imports.

6. The exchange rate regime began to show signs of strain in 2003. Belarus has a crawling band regime that is de jure linked to the Russian ruble, but which de facto tracks the U.S. dollar. Despite warnings from the staff about the impossibility of pursuing an overdetermined system for long, their approach did prove useful in bringing down inflation during 2001–02.6 It worked because the Central Bank of Russia (CBR) was also targeting the dollar, but it became less sustainable as the Russian ruble began to appreciate in 2003. Thus, the rubel appreciated by 9½ percent in real terms against the dollar during 2003, while depreciating by almost 10 percent vis-à-vis the ruble. (The real effective exchange rate depreciated by 7½ percent.7)

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Gross International Reserves

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

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Gross International Reserves

(In months of imports of goods and services)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

Source: IFS, International Monetary Fund
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Belarus: External Trade Developments

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

Sources: Ministry of Statitstics and Analysis, NBB, and Fund staff estimates.

7. Growing demand for money contributed to gradual disinflation despite relatively lax monetary policy. Led by increases in NFA and credit to government, reserve money grew by about 50 percent in 2003, giving rise to the underlying pressure seen in the core inflation numbers. Moreover, the budget was modified at the end of December to permit the NBB to double the flow of inflationary budget financing in 2003; as a result two thirds of the reserve money growth stemmed from credit to government. CPI inflation declined despite these large increases, as rubel broad money velocity fell by 17½ percent. The NBB reduced the refinance rate from 38 percent at end-2002 to 23 percent at present (still positive in real terms).

Contributions to Reserve Money Growth

(quarter-on-quarter, in percent)

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Source: National Bank of Belarus
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Monetization

(M2 as percent of GDP)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

Source: IFS, International Monetary Fund

8. Despite good reported soundness indicators, the banking sector is increasingly vulnerable. With 80 percent of the banking system being state-owned, and at least ¾ of banking system exposure to state-owned enterprises, the government’s role in the financial sector remains considerable.8 Notwithstanding their commitment under the 2001 SMP to eliminate directed lending, the president and the cabinet have continued to issue decrees and resolutions “recommending” quantitative lending targets to the six largest banks for favored projects, regions and sectors. At the same time, senior officials, including the president, have also become concerned about the level of non-performing loans (NPLs). As a result, the NBB required banks to ensure that the level of NPL fell below specific thresholds by end-2003. These thresholds were indeed met, with NPLs reportedly falling from 14.4 percent of loan portfolio at end-2001 to less than 4 percent at end-2003. Much of the improvement was due to portfolio growth, but the authorities also attribute it to strengthened payments discipline and the weaker dollar (which made it easier to repay foreign currency loans). The staff, however, fears that much of the reduction in NPLs was due instead to “evergreening” (replacing NPLs with new loans). Capital adequacy ratios and liquidity are reported at satisfactory levels as well, though underprovisioning is substantial.9 With full loan provisioning, the banking system would have reported losses during three of the past four years. As the number of loss-making enterprises is large, the staff has expressed concern about the quality of asset classification and overall risk management techniques (Box 1).

Financial and Corporate Sector Vulnerability

Financial sector vulnerability indicators are belied by weak corporate sector figures. On paper, the share of non-performing loans is declining, but corporate sector profitability is weak, suggesting that bank assets may be more impaired than official indicators show. In addition, the high level of dollarization suggests a significant risk of currency mismatches, as many borrowers of foreign currency have largely rubel receipts.

Belarus: Financial Soundness Indicators for the Banking and Corporate Sectors (2000-03)

(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 governement and the NBB.

Fitch ratings for short-term debt of Belarusbank and Priorbank.

Structural Reform Progress

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

Source: EBRD Transition Report 2003.Note: Minimum score (little progress) is 1 and maximum score is 4.5 (“4+”) except for the share of private sector, which is renormalized between 0 and 5. The privatization indicator is an average of the small-scale and large-scale privatization scores.

9. With a few exceptions, structural reforms seem to have stalled. Energy sector cost recovery levels—particularly for households—rose significantly in 2002 and early 2003, and collections improved. But utility tariff increases slowed subsequently, and favored enterprises or sectors continue to face preferential utility tariffs. The business environment remains difficult, although the licensing regime for small businesses was streamlined. The size of the public sector is estimated at about 80 percent of GDP, and privatization has not progressed, including for the seven largest petrochemical firms. Staff advice to the contrary notwithstanding, a recent presidential decree substantially expanded the scope of the golden share (Box 2). Similarly, the bankruptcy law was changed to make it more difficult to restructure insolvent enterprises.

The Golden Share in Belarus

The golden share mechanism in Belarus differs sharply from international practice. In particular, the Belarusian authorities appear to be alone in retaining the right to issue a golden share after a firm has been incorporated and privatized. Moreover, in most countries the state is usually permitted to exercise its golden share powers to affect only a limited range of actions taken by a firm’s board of directors. For example, in the UK, France and New Zealand, golden share powers have only entitled the state to veto sales of large shareholdings to third parties, and then normally only for reasons of national security.

The golden share was introduced in Belarus in 1997, reportedly in order to protect the interests of the state (especially in the areas of defense and safety). The decree stipulated that the golden share could be introduced into any company where the state owns at least one share (even if not stipulated at the time of incorporation) and allowed the state to veto shareholders’ decisions on restructuring and liquidation of the enterprise, changing its capital, use of net profits, and appointment of the manager. By end-2003, the golden share had been introduced in about 25 enterprises, many of which had little to do with national defense. For example, in 2000 the state used the golden share to block the sale of a 51 percent stake in a confectionary factory (in which the state share was only 2.5 percent).

During the past two years, the authorities have considered proposals to limit, if not eliminate, the use of the golden share.* Specifically, it was suggested that the golden share be limited to strategic enterprises, that it only be introduced at the corporatization stage, and then only for a specified period. However, on March 1, 2004, the president signed a decree substantially expanding its scope. Under the decree, the state can not only veto, but also take independent decisions in enterprises with a golden share, including in operational matters, and the share can now be introduced in all companies which were initially state-owned, even if 100 percent private.

* Progress toward abolition of the golden share was a structural benchmark under the 2001 SMP.
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Electricity Tariffs

(In US cents per k Wh)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

Source: Belenergo
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Energy Consumption, 2003

(In percent of total)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

Source: Belenergo

II. Policy Discussions

10. High inflation and delayed structural reforms are the key problems Belarus faces, as they are likely to undermine growth over the medium term. Ultimately, the source of the high inflation is fiscal policy—including quasi-fiscal activities—since lax monetary policy essentially accommodates the needs of public finance. At the same time, the low level of reserves gives rise to significant external vulnerability, particularly in light of the Belarusian exchange rate regime. Although progress toward a currency union with Russia dominated the 2003 discussions, there is much less momentum in this direction at present (Box 3).

Belarus-Russia: Status of the Currency Union

There was only moderate progress toward establishing the currency union during 2003. A key technical agreement was initialed in August on converting to the Russian ruble during the first half of 2005. Under this agreement, two Belarusian representatives would be appointed to the CBR Board of Directors, and a short-term CBR loan of up to Rub 20 billion ($650 million) could be available to the NBB to ensure stability in the payments system. In addition, a bilateral credit to the government is under consideration (subject to ceilings on debt and deficits). The agreement postponed a decision about the conversion exchange rate, but most observers expect it to be at or close to the market rate.

At the same time, the authorities in both countries are sending mixed signals about their readiness to create a currency union. On paper, they still confirm the agreed timetable, which envisages a peg of the Belarusian rubel to the Russian ruble in mid-2004 and “ruble-ization” from January 2005. However, President Lukashenko has repeatedly asserted that he will not give up the rubel without additional financial commitments. For their part, senior Russian officials have suggested the currency union be pushed back to 2006. Russia has also stepped up the financial pressure on Belarus, chiefly in the form of higher delivery prices for natural gas. Indeed, Gazprom disrupted deliveries to Belarus twice during early 2004, citing persistent payments arrears.

Privatization of Beltransgaz is a major stumbling block. A 2002 agreement granted Belarus access to natural gas from Gazprom at internal Russian prices, conditional on the sale of a significant stake in the gas transport and distribution firm Beltransgaz. President Lukashenko has since put up hurdles to divestiture of Beltransgaz, and Gazprom, in turn, has threatened to raise gas delivery prices substantially in 2004 (in which case Beltransgaz would raise transit fees paid by Gazprom).

Belarus-Russia: Natural Gas Trade in 2004

(In millions of US dollars)

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Sources: Belarusian authorities and IMF staff estimates

11. Against this background, the discussions centered on the following questions:

  • Is the authorities’ macroeconomic framework realistic and appropriate?

  • Is there a need for monetary and fiscal policy adjustment in order to deliver lower inflation, reduce vulnerability and set the stage for stronger medium-term growth? If so, how large should the adjustment be?

  • What is the appropriate exchange rate regime, particularly if prospects for a currency union are diminishing? and

  • What should be the authorities’ structural reform priorities, given that Belarus lags behind its neighbors in almost all areas?

A. Economic Integration with Russia

12. The staff maintained an agnostic view of the long-run merits of a currency union with Russia, but stressed that the timing is critical if it goes forward. As in the past, the staff argued that the long-run cost-benefit calculus is not clear on purely economic grounds (thus, the decision is mostly political). However, the staff and the authorities agreed that it would be inadvisable to enter the currency union before supportive fiscal and structural policies are in place. The staff argued that these policies are plainly not in place; in particular, core inflation remains well above that of Russia, while structural reforms lag well behind.10

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Core Inflation in Belarus and Russia

(In percent, 12-m price change)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

B. Outlook for 2004

13. The authorities noted that they target extremely robust economic growth in 2004. In line with the ambitious 2001–05 plan set by President Lukashenko, real GDP growth is targeted (not projected) at 9–10 percent in 2004. Fixed investment is to grow by 18–20 percent, while at the same time enterprises (both public and private) are being pressed to ensure that average wages rise from about $130/month at present to $190/month by end–year.11 The authorities argued that their growth targets were achievable if administrative measures were taken to tap “hidden reserves” in the economy. They also placed high hopes on a new government program to improve the business environment—though some measures in the program (e.g., streamlining the golden share) have already been rejected.

14. The staff considered the authorities’ 2004 growth objectives too optimistic, arguing that they are based on an inconsistent macroeconomic framework. First, the external environment is not conducive to a sharp jump in the growth rate, as key trading partners are growing more slowly than the authorities project for Belarus, while the terms of trade (especially for energy) are worsening. Second, the wage growth objective—which could well be scaled back in the end, given its implausibility—would undermine enterprise profitability and public finances. Finally, the authorities’ robust investment projections do not seem financeable, as (i) almost half the enterprise sector is loss-making, (ii) the authorities program a modest monetary tightening, and (iii) external financing is lacking. The staff also noted that years of high inflation have reduced growth prospects in Belarus. In the CIS, only Uzbekistan (which also had high inflation) and the Kyrgyz Republic (which suffered from a drought and a mining disaster) have had lower growth since 2001. The staff welcomed the market-oriented elements of the government plan to achieve the growth targets, but remained skeptical that it would contribute several percentage points to growth in 2004, particularly in view of the fact that similar programs have been promulgated—to little effect—in each of the past several years.

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GDP Growth and Inflation

(In percent, average 2001-03)

Citation: IMF Staff Country Reports 2004, 141; 10.5089/9781451805130.002.A001

15. On current policies, the staff projected growth at 4.8 percent—about one half the authorities’ target, owing mainly to weaker investment (given the authorities’ planned wage hikes) and a deteriorating current account. Under the staff’s reform scenario, growth would be still lower in 2004—about 4.0 percent—given the need for tighter macroeconomic policies, but would rise over the medium term (Table 5). In both cases, it is assumed that the crawling band exchange rate regime is retained at least through end-2005. The mission argued that on current policies inflation during 2004 is likely to be around 22 percent, well above the authorities’ target, given the substantial monetary impulse in late December 2003.

Table 1.

Belarus: Selected Economic Indicators, 2001-04

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Sources: Belarusian authorities; and Fund staff estimates.

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.

Consolidates the state government and Social Protection Fund budget.

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

For the authorities’ projections, rubel reserve money.

Table 2a.

Belarus: Fiscal Indicators and Projections, 2001-04

(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 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.

Table 2b.

Belarus: Fiscal Indicators and Projections, 2001-04

(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 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.

Table 3a.

Belarus: Monetary Accounts, 2002-04 (Current Policies)

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

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

For the authorities projection for 2004, increases in rubel claims.

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

In 2001-2002, the CBR disbursed Rub 4.5 billion (about US$146 million).

Table 3b.

Belarus: Monetary Accounts, 2002-04 (Reform 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.

For the authorities projection for 2004, increases in rubel claims.

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

In 2001-2002, the CBR disbursed Rub 4.5 billion (about US$146 million).