Abstract
This 2007 Article IV Consultation highlights that Belarus’s centralized economy grew rapidly over the past few years, enhancing social development. The state redistributed large and growing terms-of-trade gains stemming from favorable Russian energy pricing across the economy, boosting domestic demand. A new energy agreement, however, has abruptly reversed terms-of-trade gains. Belarus now pays Russia twice as much for gas supplies as in 2006 and a fifth more as a share of world market prices for crude oil. This resulted in an estimated loss of 5½ percent of GDP in 2007.
On behalf of the Belarus authorities, we thank the staff for the continued productive dialogue, and their helpful policy recommendations and technical assistance. The authorities welcome the increasing degree of convergence of views with the staff on the economic performance and medium term policies. Many of the policy recommendations of the staff have been reflected in the authorities’ policy decisions, such as the recently adopted program for the development of the banking sector during 2006-2010.
General Remarks
Notwithstanding the recent deterioration of the external conditions, due to a doubling of the price of energy imported from Russia, the economy continues to grow briskly. Annualized GDP growth was 8.8 percent during January-July 2007. The authorities are satisfied with the staffs recognition of their efforts and achievements in maintaining steady economic growth through most of the transition period. Indeed, with 140 percent during 1990-2006, Belarus recorded the highest GDP growth among CIS countries. The average annual growth during the last three years exceeded 10 percent. The authorities share the assessment of the Fund that, to a certain extent, the high growth is explained by the favorable terms of trade which Belarus enjoyed until the recent drastic increase of the price of imported energy. Nevertheless, the authorities believe that the growth performance is largely explained by the stable macroeconomic environment, including prudent fiscal policies, a stability enhancing exchange rate policy, declining inflation and a strengthening of the financial system. The authorities also stress the importance of the country’s favorable record in maintaining, during the last ten years, a high average investment ratio of 25 percent of GDP, which was the second highest in the CIS region.
Due to the financial constraints caused by this year’s energy price hikes, the investment ratio dropped to a still high level of 20 percent during the first half of 2007. The constraints of internal financial resources have been compensated by more available external resources. The privatization receipts are estimated to increase to 1.5 percent of GDP in 2007.
To mitigate the impact of the higher imported energy prices on the current account the authorities have adopted and are successfully implementing a comprehensive energy savings program for the period until 2011. In the first half of 2007, the energy intensity of GDP has already dropped by 14 percent.
Belarus has the lowest public debt to GDP ratio among the transition countries. The authorities therefore consider it prudent to borrow limited amounts to smooth the adjustment of the economy and to finance the energy savings program. In this, Belarus follows the successful experience of other transition countries that used additional borrowing to finance growth-promoting programs.
Given the magnitude of deterioration in the terms of trade, the drop in enterprise profitability by 1.5 percentage points to 11.9 percent is seen as moderate. Most of the decline in profitability is concentrated in the oil processing industry, which recorded a decline in its profitability from 23.1 percent to 5.3 percent. At the same time, we would like to mention that the number of loss-making enterprises has dropped from 19.5 percent to 17.5 percent.
One of the main topics during the consultation discussions was the desirable level of the pass-through to users of the higher energy import prices. The staff concluded that the pass-through of the 114 percent rise in gas import prices was incomplete as tariffs rose by 20 percent for households and by up to 89 percent for enterprises. These new tariffs represent an average pass-through of about 60 percent. The staff is advocating an immediate full pass-through. However, the authorities consider a more gradual approach more consistent with long term social and economic stability.
Monetary Policy - Exchange Rate Policy and External Competitiveness - Financial Sector Policies
Moderate wage growth will be a key factor in preserving the competitiveness of the economy and in helping to offset the recent terms of trade losses. Thus, the average wage growth in 2007 will be much closer in line with labor productivity increases, as recommended by the staff. More modest wage increases will weaken consumer demand growth. As a result, notwithstanding the pressures caused by sharply rising energy prices and by the higher inflation in two main trade partners, i.e. Russia and Ukraine, consumer prices in Belarus rose by only 3.6 percent in the first half of 2007, slightly above last year’s indicator of 3.1 percent.
The authorities are committed to further reducing inflation by pursuing prudent monetary policy. The de facto peg to the U.S. dollar served as a strong stabilizing factor. Along with tight monetary and fiscal policies, it helped to reduce annual inflation to a comparatively low level of 7 percent in 2006.
Money growth is slowing significantly. The amount of cash in circulation rose by 7.5 percent in the first half of the year, compared with 23.3 percent in the same period last year. The rubel money supply rose by 5 percent in the same period, down from 18.6 percent in the same period last year. As a result, core inflation was 0.6 percent in June 2007.
Pegging the rubel to the U.S. dollar resulted in a gradual devaluation of the rubel versus the Euro and the Russian ruble, which was instrumental in maintaining competitiveness of Belarus in relations with its main trade partners.
Addressing the concerns expressed during last year’s Board meeting, the authorities made an effort to boost the level of international reserves by 70 percent during the first half of 2007 to reach $2.4 billion, after the sale of state enterprises to foreign investors.
The growth potential of the financial sector is promising. The authorities intensified efforts to attract foreign capital for the banking sector and to see reputable foreign banks becoming strategic owners. The new banking code and adhering to best international prudential standards have triggered increased interest of foreign investors in the banking system. The participation of foreigners in the capital stock of domestic banks rose from 8 percent last year to 14.3 percent in June 2007. The recent sale of two medium-sized banks to foreign investors will contribute to stronger competition and improved business standards. Several other banks are preparing themselves for a significant participation in their capital by foreign investors. This year, most of the large banks in Belarus obtained substantial credit lines with foreign banks without using state guaranties. This shows the improved creditworthiness of Belarus as confirmed by the recent Standard & Poor’s B+ rating for long-term foreign currency debt.
To stimulate the critically important SME growth, the authorities and the EBRD, with the support of IFC and bilateral donors, have started the process of creating a special bank for micro financing. The new institution will support the development of SMEs by providing credit and other financial services, particularly in regions outside the capital. The project is expected to have a high transition impact by demonstrating to local banks the viability of SME lending.
Fiscal Policy
The 0.5 percent of GDP fiscal surplus in 2006 and the 1.9 percent of GDP surplus in the period January-May 2007 confirm the tradition of prudent fiscal policies with high tax revenues, strong tax administration, and a disciplined expenditure management. As it is recognized in the Staff Report, in the first five months of 2007 the authorities have implemented stricter fiscal policies than budgeted.
To reduce expenditures in response to the higher cost of imported energy, in addition to the expenditure cuts already undertaken, the authorities are finalizing the reform of the social security system which will be implemented from January 1, 2008 onwards. The new system envisages drastic cuts in all kinds of subsidies, resulting in substantial savings for the budget. The authorities are also committed to make subsidies compliant with WTO rules.
Last year, the taxation of financial and nonfinancial enterprises has been harmonized. The reform of the tax system is ongoing, and aims at reducing the overall tax burden and further simplifying taxation, particularly for small businesses.
Structural Reforms
The authorities are stepping up their privatization program which includes the sale of the gas transportation network “Beltransgas” and several large manufacturing enterprises which will be offered for sale within the next 6 months.
During the last two years IFC has doubled its activities in supporting private business in Belarus, increasing its investments from $20 million in 2005 to $40 million.
To create a better business environment for SMEs, last March the authorities amended and further simplified the tax regulations for SMEs. The government plans to reduce, still this year, the number of profit taxes for businesses and the frequency of tax reporting. The procedures and formalities for setting up and closing businesses, and for obtaining licenses are all in the process of being simplified.