Republic of Belarus
First Review Under the Stand-By Arrangement, and Request for a Waiver of Performance Criterion, Augmentation of Access, and Modification of Performance Criteria: Staff Report; Staff Supplement; Staff Statement; Press Release on the Executive Board

This paper discusses key findings of the First Review under the Stand-By Arrangement for the Republic of Belarus. All end-March 2009 quantitative and continuous performance criteria and structural benchmarks were met, except for the net international reserves target, which was missed by US$221 million. A sharp fall in demand for Belarus’s exports and a worsening of the capital account has led to the re-emergence of a substantial financing gap for 2009. The authorities have committed to adjust exchange rate and monetary policies, and to maintain a balanced budget despite lower revenue.

Abstract

This paper discusses key findings of the First Review under the Stand-By Arrangement for the Republic of Belarus. All end-March 2009 quantitative and continuous performance criteria and structural benchmarks were met, except for the net international reserves target, which was missed by US$221 million. A sharp fall in demand for Belarus’s exports and a worsening of the capital account has led to the re-emergence of a substantial financing gap for 2009. The authorities have committed to adjust exchange rate and monetary policies, and to maintain a balanced budget despite lower revenue.

I. Recent Developments and Program Performance

1. Belarus’s strong program has been undermined by external shocks and inconsistent implementation, but the authorities’ recent actions will reinforce it. The program supported by the SBA helped Belarus to weather a difficult first quarter of 2009. The 20 percent devaluation of the rubel against the U.S. dollar on January 2 and the adoption of a peg to a basket of currencies significantly improved Belarus’s external competitiveness.1 Maintenance of a balanced budget, despite a sharp fall in revenue, was crucial in supporting macroeconomic stability. The authorities have been confronted by extraordinary external shocks, and their response has sometimes been hesitant and inconsistent, especially in the area of monetary policy. However, in recent weeks, the authorities have renewed and deepened their commitment to stability and sustainability.

2. The deterioration of the global economy hit output and the balance of payments hard in the first quarter. Economic activity slowed significantly in response to a decline in external demand. GDP grew by 1.1 percent year-on-year in the first quarter, compared with an expansion of 11.2 percent a year earlier (Figure 1). Industrial output fell by 4.5 percent despite substantial accumulation of inventories, reflecting lower exports. Consumer prices increased by 6.5 percent in the first four months, and 14.7 percent in the 12 months up to April, partly as a result of the step devaluation and increase in communal service tariffs early in the year. However, monthly inflation in April fell to 0.4 percent, as the negative output gap began to depress prices. Flagging demand from major trading partners contributed to an increase in current account deficit in the first quarter to $1.86 billion from $0.4 billion a year earlier (Figure 2). The first-quarter deficit was projected at $0.8 billion in the program.

Figure 1.
Figure 1.

Belarus: Real Sector, 2006–09

Citation: IMF Staff Country Reports 2009, 260; 10.5089/9781451805314.002.A001

Sources: Belarus authorities; and IMF staff calculations.1/ Lagged 12-month moving average of industrial production.
Figure 2.
Figure 2.

Belarus: External Sector, 2008–09

Citation: IMF Staff Country Reports 2009, 260; 10.5089/9781451805314.002.A001

Sources: Belarus authorities; and IMF staff estimates.

3. Belarus has also been adversely affected by cross-currency movements, and a capital account shock. The depreciation of the Russian ruble against the U.S. dollar early this year hit Belarus in two ways. Because both the Russian ruble and the U.S. dollar are in the currency basket to which the Belarusian rubel is pegged, the Belarusian rubel appreciated against the Russian ruble, causing Belarus’s exports to become temporarily more expensive for its major trading partner. At the same time, it fell against the dollar (the main alternative currency for household deposits), complicating the authorities’ efforts to instill confidence in the new exchange rate regime. This, combined with initial uncertainty following the January 2 devaluation, led many households to switch from rubel to foreign exchange deposits, leading to an increase in deposit dollarization from 39 percent at end-2008 to 53 percent by end-March (Figure 3).2 Private sector financial flows were slightly higher than expected, with FDI roughly in line with projections and lower commercial bank rollover rates on external loans more than offset by higher trade credit inflows. Nonetheless, the higher current account deficit and deposit switching caused a shortfall in NIR against the end-March program target by $221 million. Moreover, NIR continued to decline in the second quarter by about $1 billion (versus a projected increase in the original program), reflecting in part the continued effects of lower exports and renewed capital outflows due to public uncertainty about economic prospects.

4. The authorities were sometimes slow to react and hesitant to use policy instruments in response to the worse-than-projected external environment. The National Bank of the Republic of Belarus (NBRB) initially allowed the exchange rate to appreciate against the central parity, despite loss of reserves, in an attempt to limit currency substitution by keeping the dollar/rubel exchange rate as stable as possible. Under pressure to support liquidity and to permit banks to supply credit to the economy, the authorities have also been slow to tighten monetary policy. Indeed, on April 15, the NBRB cut the interest rate on overnight liquidity support by 2 percentage points, signaling a somewhat looser policy stance. Credit to the economy (measured at program exchange rates) increased by 5.4 percent during the first four months of 2009. Much of this increase was in subsidized credits for residential housing and construction.3 There was also a considerable build up of inventories in January and February, as many state-owned enterprises kept producing to meet government-set targets even though, due to the fall in export demand, they could not sell what they produced.

uA01fig01
Sources: Belarus authorities; and IMF staff estimates.
Figure 3.
Figure 3.

Belarus: Monetary Developments, 2008–09

Citation: IMF Staff Country Reports 2009, 260; 10.5089/9781451805314.002.A001

Sources: NBRB; and IMF staff calculations.

5. In other respects the authorities acted forcefully to support the program.

  • They met the fiscal performance criterion despite much lower revenue. Profit taxes and customs duties were particularly hard hit. Total profits in the economy declined by 17 percent in Q1 2009 compared with Q1 2008, leading to a 20 percent fall in profit tax revenue (Figure 4). Duties on oil exports were affected by the fall in prices and cuts in rates (necessary under Belarus’s agreements with Russia), and import tariff revenue fell along with imports. In response, expenditures on goods and services were cut, except for purchases for education and health. Investment projects were cancelled or postponed, unless they were already close to completion or in priority areas.

  • They met the NDA performance criterion. Although monetary policy was not tight enough to offset the effects of the external shock on NIR, the authorities did keep credit tight enough to enable them to meet the end-March NDA performance criterion.

  • They have pursued agreed structural reforms. The authorities have discontinued the practice of placing central and local government deposits in commercial banks and engaging in directed lending using these deposits. They have not extended the regulatory act imposing a general ceiling on monthly prices increases of ½ percent, thereby meeting the structural benchmark for end-March. They have also reduced the number of goods and services subject to price regulation, and are no longer announcing medium-term wage targets.

6. The financial sector has so far weathered the crisis well, though banks’ financial soundness indicators have deteriorated (Table 6). The average capital adequacy ratio (CAR) declined by 1.6 percentage points to 20.2 percent. The nonperforming loan (NPL) ratio almost doubled to 1.1 percent, and, while it remains relatively low, it may rise as the recession impacts more firms and as the NBRB brings its NPL classification closer to international practice. Banks lost 20 percent of their rubel deposits during the first quarter, but a corresponding increase in foreign exchange deposits and timely rubel liquidity support by the NBRB averted potential liquidity problems. However, strains in banking system liquidity continue: as of end-March, a few large state-owned banks did not meet prudential norms for the ratio of liquid assets to total assets or the short-term liquidity ratio.

Figure 4.
Figure 4.

Belarus: Fiscal Developments, 2008–09 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 260; 10.5089/9781451805314.002.A001

Sources: Belarus Authorities; and IMF staff estimates.1/ General government. Cumulative for the year.

II. Policy Discussions

A. Macroeconomic Framework

7. The deterioration in the external outlook gives rise to large financing gaps in 2009 and 2010. The sharp decline in projected export demand in partner countries is expected to be only partially offset by reduced imports stemming from domestic demand contraction. The current account deficit would rise to almost 10 percent of GDP in 2009, and remain above 5 percent in the medium term. The capital account would also worsen slightly because of lower-than-projected rollover of syndicated loans and parent bank financing to Belarusian subsidiaries, and because, absent policy tightening, no significant reversal of currency substitution can be expected. On unchanged policies, gross reserves at end-2009 are expected to be about $2½ billion lower than originally targeted. There would also be a large shortfall in reserves in 2010, and reserve coverage would fall further over the medium term.

8. Discussions on how to close the financing gap focused on finding the right balance between financing and adjustment and among different means of adjustment.

The authorities recognize that the deterioration in the outlook for major trading partners was likely to have long-term effects, which would need to be offset by adjustment. But they also believe that some of the worsening is likely to be temporary, meriting increased financing. With regard to the means of adjustment, the authorities wished to avoid any major changes in the newly adopted exchange rate regime. They also emphasized that the commitment to the balanced budget is an important policy anchor. At the same time, they saw limits to the extent to which monetary policies could be tightened, given the needs of the real economy, and the desire to avoid massive bankruptcies and employment loss. The staff noted that this approach put a heavy burden on fiscal policy adjustment. The staff further noted that alternative approaches involving some loosening of fiscal policy and greater exchange rate and monetary policy adjustment could also close the financing gap. However, the staff recognized that the authorities’ continued reliance on the balanced budget was consistent with their demonstrated ability to deliver on planned fiscal adjustment. The staff also considered that the combination of continued fiscal tightening, tight monetary policy and modest exchange rate depreciation under the authorities’ preferred approach would be sufficient to alleviate pressures on international reserves and restore external stability.

9. The agreed-upon approach involves adjustment making use of all major policy instruments. The authorities will maintain current fiscal policies, but allow the rubel to depreciate within the exchange rate band, tighten monetary policy, and step up structural reforms. (Prior actions, quantitative and continuous performance criteria, as well as structural benchmarks, are listed in Tables 2 and 3 in the Letter of Intent (LOI).)

  • Early exchange rate depreciation (compared to the more gradual depreciation through 2009 which the authorities were planning) is expected to contribute to a decline in the current account deficit to 7.8 percent of GDP in 2009, and to below 6 percent of GDP in 2010.

  • A tighter monetary policy in 2009 will result in lower monetary aggregates, and near-zero real growth of credit to the economy.

  • The balanced budget target will help contain domestic demand.

Taken together, these measures are projected to improve the balance of payments by about $1.5 billion. With the proposed augmentation of the SBA and additional financing from the World Bank, this would be sufficient to close the 2009 financing gap (Table 7).4 Structural reform, notably a stepped up privatization program, will improve the prospects for growth and the balance of payments in 2010 and in the medium term.

Closing the 2009 Financing Gap

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Source: IMF staff estimates.

10. These policies, which are described in more detail below, are expected to stabilize the economy, increase reserves and ensure medium-term sustainability. GDP in 2009 would contract by about 3 percent, reflecting the adverse external environment and declining domestic demand, but with some restoration of external competitiveness, the economy would recover faster in 2010 to about 2½ percent. In the medium term, as structural reforms take root, growth would increase. Inflation would fall to 11 percent at the end of 2009, as tighter monetary policy more than offsets the impact of more depreciation, and would fall to single digits from 2010 onward. Improved competitiveness, stemming from increased exchange rate flexibility and structural reforms, combined with fiscal discipline ensures medium-term sustainability through stronger current account balances and low public debt. The improvement in the external current account and inflow of privatization-induced FDI would lead to increased reserves coverage.5

B. Exchange Rate and Monetary Policies

11. The exchange rate depreciation will facilitate adjustment of the current account and alleviate pressure on reserves (Box 1). Maintaining the rate at the current central parity would not address the competitiveness issue that has emerged, and in the long run would not allow the maintenance of exchange rate stability as this ultimately depends on the balance of payments being sustainable. The authorities have therefore taken advantage of the flexibility embedded in the current exchange rate band by depreciating by nearly 5 percent relative to the central parity in May-June. The updated stress test on banks shows that the effects of this adjustment on commercial banks are manageable (Box 2).

Real Effective Exchange Rate: How Much Adjustment is Enough?

External stability requires a credible exchange rate regime supported by a consistent domestic policy mix. The staff’s analysis suggests that the depreciation in the nominal exchange rate that has taken place during May and June, if supported by strong domestic policies, will be sufficient to alleviate pressures on international reserves and restore external stability.

Based on the exchange rate prevailing at end-April and the authorities’ policy intentions at that time, standard exchange rate assessments suggested that the real effective rate was marginally above its equilibrium level. The current account norm for Belarus was estimated at -3.6 to -4.7 percent of GDP (Box 1 in IMF Country Report No. 09/109, page 11), and the current estimate of the underlying current account deficit was close to 6 percent of GDP. Based on this assessment, the REER was 4–6.5 percent above its equilibrium level. Given the changing macroeconomic environment and recent policy measures, the assessment of the exchange rate may change once the situation stabilizes.

The strengthening of polices in the program, combined with the adjustment of the nominal exchange rate since end-April brings the REER close to the medium-term equilibrium level. At the end of April, the real effective exchange rate, which is a basic indicator of price competitiveness of Belarusian exports, was only 6 percent above its pre-crisis (July 2008) level. The depreciation of the rubel within the exchange rate band since then, as well as recent sizeable appreciation of the Russian ruble, is sufficient to fully offset the real appreciation observed since August 2008. Prudent wage policies envisaged under the program would restrain wage costs and, combined with tight monetary polices to keep inflation low, will boost the competitiveness of Belarusian products. Thus, the combination of adjustment measures envisaged in the program would result in a sustainable medium-term current account.

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Banking System Stress Tests

Stress tests based on end-March data indicate that while the capital adequacy ratio would remain above prudential norms under most shock assumptions, a run on deposits would threaten banking system stability.

Sensitivity tests indicate that regulatory capital would deteriorate in case of a sizeable increase in NPLs but still remain above its statutory norm, and that the direct market risks would be limited. The capital adequacy ratio (CAR) would remain above 13 percent after an increase in nonperforming loans by 15 percentage points, close to 20 percent after a 20 percent devaluation and close to 20 percent after a 3 percent upward shift in the rubel yield curve. The table below illustrates the impact on banks by ownership type.

Stress-tests based on macro scenarios suggest that CARs can withstand the policies agreed in the revised program well, but would deteriorate significantly in a scenario with stronger depreciation. Under agreed policies (a modest depreciation, a 2 percent increase in rubel deposit rates and a 5 percentage points increase in NPLs), the CAR would remain above statutory norms in all banks with the system-wide ratio of above 17 percent. In a more drastic scenario (20 percent depreciation, 5 percent increase in the rubel interest rates and a 10 percentage points increase in NPLs), CARs in three banks—representing 12 percent of the total banking system assets—would fall below the norm while the system-wide ratio slide to 15 percent. As current CARs are most likely overstated given imperfections in current loan classification (which is to be remedied by September), a reduction in the CAR by 5 percent in the second scenario poses considerable risk to financial system stability, indicating the need for contingency plans.

CAR Stress Tests, end-March 2009

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A major vulnerability of Belarus’s banking system stems from the precarious liquidity situation. The liquidity stress tests indicate that a 10 percent withdrawal of rubel liabilities would bring the ratio of liquid to total assets below the statutory norm in 4 banks (70 percent of banking system assets). Two banks (45 percent of the banking system assets) would not comply with the current liquidity norm. Also, the system-wide short-term liquidity ratio would fall to 83 percent (against the statutory norm of 100 percent). “Deposit-switching”—similar to what was observed after January devaluation—would be less detrimental for liquidity condition, but would increase foreign exchange exposure (many banks would not comply with the norms on the net open foreign exchange position). Raising the average interest rate on rubel deposits as well as reducing devaluation expectations are expected to stimulate accumulation of rubel deposits and alleviate banks’ liquidity problems.

Liquidity Stress Tests, end-March 2009

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Sub-groups by ownership are state owned banks (SOB), foreign banks (FB) and private banks (PB).

12. The NBRB plans to tighten monetary policy to support the necessary external adjustment. Broad money and reserve money growth in 2009 will be lower than in the original program, due to lower projected output and some increase in velocity. Reflecting this, the NDA targets have been revised upward, but by less than the rubel equivalent of the projected shortfall in NIR (quantitative PC, LOI ¶11 and LOI Table 2). Central bank credit to commercial banks and credit to the economy would grow in nominal terms, but real growth in credit to the economy would still be close to zero. Slowing domestic demand would support external adjustment.

13. To support tighter monetary policy, the NBRB will also act to increase interest rates. To increase the spread between rubel and foreign exchange interest rates and facilitate a switch back to rubel deposits, the NBRB has recommended that commercial banks raise rubel interest rates on new term deposits of households to levels 2 percentage points above average levels for March, and has reversed the 2 percentage point cut in the interest rate on overnight lending by the central bank (which forms the upper limit of the interest rate corridor) (prior actions, LOI ¶11 and LOI Table 3). The NBRB will also manage liquidity in Lombard auctions to ensure that tight NDA targets are met. Interest rates could be gradually reduced as confidence is restored and exchange market stability is achieved.

C. Fiscal Policy

14. Revenue is projected to be lower than programmed by 5½ percent of GDP as a result of adverse exogenous shocks. The reduction of revenue from customs duties on oil exports (3 percent of GDP) reflects the significant cut in rate applied by Russia. Profit tax, personal income tax, and VAT collections will be affected by lower profits, income, and consumption. Tax reforms, which are being implemented to improve the structure of the tax system and to reduce the burden of taxation on enterprises, will cause further revenue losses. The profit tax rate will be reduced by 4 percentage points to 20 percent (0.7 percent of GDP), and several small taxes and fees will be eliminated, including the local sales tax on goods and services (½ percent of GDP). To contain the revenue shortfall, the VAT rate will be increased by 4 percentage points (1 percent of GDP), and the authorities plan to reduce exemptions.6 In addition, excise rates on selected goods were raised by 10 percent in June. The staff believes that the revenue measures taken by the authorities are an appropriate response to the crisis. The reduced profit tax rate will support domestic production through better profitability, while the higher VAT rate will support revenue. In the context of the authorities’ medium-term reform program to reduce the tax burden, consideration could be given to reducing the VAT rate to levels applied in the region. Revenue losses from this could be offset by reducing exemptions and the number of goods subject to lower VAT rates.

15. Expenditure cuts will focus on investment and other untargeted current expenditures. Public investment will decline by 4 percentage points of GDP compared with 2008, due to a stricter selection of projects guided by the completion rate of projects and the need to safeguard investment in social and growth-enhancing sectors. Savings on goods and services (1 percent of GDP) will be achieved by rationalization measures. The authorities also decided to postpone any wage increase to September at the earliest (0.2 percent of GDP). However, with World Bank support, targeted social assistance programs will be improved to shield the poorest from the impact of the crisis by (i) increasing the income eligibility threshold; (ii) extending the duration of the assistance; and (iii) including into these programs the housing and utility allowance program. The staff welcomed the measures taken by the authorities, and called on them to reduce generalized subsidies on interest rates, utilities and transportation, and scale up income-based targeted assistance. In that regard, World Bank assistance will be important.

16. The coverage of the performance criterion is expanded to cover local governments (quantitative PC—LOI ¶12 and LOI Table 2). The original program was designed based on the assumption that local governments’ budgets will also be balanced. However, local governments accumulated surpluses in 2008, which they are entitled to use to finance expenditure in 2009. To reflect the full effect of fiscal policy on the economy, the authorities and staff agreed to base the revised target on the general government balance, but to include an adjustor capped at 1 percent of GDP, for local governments’ deficits. The budget target will also now include the Social Protection Fund, which is projected to be in balance for the year as a whole.

D. Deepening Structural Reform

17. The original program contained several important structural measures in the areas of financial sector reform and of price liberalization. Key measures in the financial sector included the elimination of new directed lending financed with government deposits (continuous structural benchmark—LOI ¶17, bullet 2); starting the process of privatizing the state-owned banks (structural benchmark—LOI ¶17, bullet 3); and a commitment to bring loan classification and provisioning into line with international best practices. The program also included measures to promote price and wage liberalization, notably the discontinuation of the ½ percent ceiling on monthly price increases (structural benchmark—LOI ¶2, bullet 4). Each of these was reflected in structural benchmarks.

Prior Actions and Structural Benchmarks

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18. The revised program goes beyond this in several respects.

  • A stepped-up privatization effort. The government, working with the World Bank, will submit a draft Privatization Law to Parliament by September 2009 (structural benchmark—LOI ¶21). They will also submit to the President, by September, a draft decree on establishing a Privatization Agency charged with preparing enterprises for privatization, with power to hire advisors from banks, accounting firms, and other private companies to support the process. The Agency, once established, will consult with the World Bank and identify, by November 2009, five large SOEs as candidates for privatization. It will further select a reputable financial advisor to facilitate the process, with the aim of offering the controlling stakes in these SOEs for sale through an open, international, transparent, and competitive tender by February 2010.

  • Improving NBRB governance. To address weaknesses in the NBRB’s legal framework and accounting procedures identified in the Safeguards Assessment, the authorities have agreed to take several measures. The most important are: (i) adopting by end-2009 amendments and supplements to the NBRB Statute and the Banking Code aimed at improving the NBRB’s financial and operational independence (structural benchmark—¶19); and (ii) commissioning quarterly audits of the data underlying the NIR and NDA performance criteria. An audit of the end-March data has already been conducted, and minor inconsistencies in the calculation of exchange rates have been corrected.

  • Improving the regulatory and supervisory frameworks. Assisted by Fund TA, the NBRB has agreed specific measures to bring loan classification in line with international practices (structural benchmark—LOI ¶16, bullet 3). This measure will allow an objective assessment of financial sector soundness.

  • Structural reforms supporting business and investment. The authorities are committed to reducing further the list of social goods and services subject to administrative price controls. They will also take steps to stop the application of mandatory wage policy and output and employment targets to companies in which the government has a minority shareholding.

E. Risks

19. There are risks that a further deterioration in the global outlook or a substantial depreciation of the Russian ruble could worsen the balance of payments. If the global recession is longer or deeper than projected, Belarus’s exports, output and fiscal revenue will be hit harder. If the Russian ruble depreciates again, Belarus could be caught in the same situation as in January, with appreciation against the Russian ruble causing problems in the current account, and depreciation against the dollar reducing confidence in the currency. On the other hand, there are upside risks to the global outlook, and the Russian ruble could appreciate further. Moreover, the authorities have shown that they have the capacity to take additional measures if necessary to ensure the achievement of the program objectives, and the authorities have committed to use the flexibility available to them under their exchange rate regime and to tighten monetary policy as necessary to minimize reserve losses.

20. Risks from a shortfall in projected external finance are limited. The only finance expected to come in under the program is the final $500 million of a $2 billion loan from Russia, which the Russian authorities have indicated that they expect to disburse in 2009, and a $200 million Development Policy Loan from the World Bank. Belarus has also agreed a swap agreement with China for close to $3 billion. However, the impact on the balance of payments is expected to be limited, as this is essentially a mutual trade finance agreement, and Belarus’s trade deficit with China is modest. Rollover rates on commercial debt need to be monitored closely, though the remaining repayments falling due in 2009 are only about $1 billion. A greater risk comes from additional currency substitution, though higher deposit interest rates will help to mitigate this risk. There is also the possibility of Belarus obtaining more financial support. In particular, Belarus’s new membership of the EU’s Eastern Partnership increases opportunities for closer trade and financial ties with, and financial support from, the European Union.

21. Policy slippages pose a greater risk. The authorities’ response to the crisis has not always been consistent or orthodox. The government has clung too long to output targets and revenue projections framed in 2008, distorting the activities of state enterprises, and complicating economic policy making.7 Some policies, while unorthodox, have been a sensible reaction to the crisis, for example, instituting shorter working weeks and unpaid vacations to avoid laying off workers. On the other hand, another anti-crisis measure, increased recourse to subsidized credit for construction, has budgetary costs, and if extended too broadly could crowd out lending to the private sector. The authorities have agreed to consult closely with staff on policies in the remainder of the program. The Article IV Consultation, which will take place at the same time as the second review, will also offer an opportunity to discuss policies in a broader context.

III. Program Modalities, Capacity To Repay And Safeguards Assessment

22. The attached Letter of Intent describes the authorities’ progress in implementing their economic program, and sets out policy commitments for 2009 and beyond.

  • The authorities request a waiver of nonobservance of the end-March NIR performance criterion, based on corrective actions taken or planned in response to less favorable external environment, including allowing depreciation of the exchange rate within the band and tightening monetary policy.

  • The authorities, following discussion with staff, also request a modification of the performance criteria for end-June 2009 to reflect the revised macroeconomic framework. The LOI also sets performance criteria for end-September 2009, as well as indicative targets for end-December 2009.

  • The authorities agreed to establish some of their reform commitments as new structural benchmarks. Specifically, the authorities will submit to the Head of State a draft decree on establishing a Privatization Agency, by September 30, 2009 (LOI ¶21). Also, following the safeguards assessment recommendations, the authorities will prepare, by end-December 2009, amendments to the NBRB Statute and the Banking Code in consultation with the Legal Department of the Fund to ensure the operational and financial independence of the NBRB (LOI ¶19).

23. Based on the policy adjustments described above, the authorities requested an augmentation of the SBA by $1 billion. Spread evenly across the remaining disbursements, this would close the financing gap in 2009. The augmentation would result in total access of 587 percent of quota, of which 474 percent of quota would be disbursed in 2009. The staff’s assessment is that Belarus meets the exceptional access criteria (Box 3), and the program would leave Belarus in a position to discharge its obligations to the Fund in a timely manner.

Exceptional Access Criteria

Belarus’s exceptional financing needs stem from the current account shocks it is experiencing, with the situation aggravated by capital account pressures. In such cases the Fund’s exceptional access framework requires the proposed access be justified in light of all four of the following substantive criteria. Based on staff assessment, Belarus meets all the criteria.

Criterion 1The member is experiencing or has the potential to experience exceptional balance of payments pressures on the current or the capital account, resulting in a need for Fund financing that cannot be met within the normal limits. Belarus is currently experiencing exceptional current account pressures from a sharp decline in its exports, stemming from the global financial crisis. Lower rollover of bank credit and faltering prospects for FDI are expected to result in a significant decline in capital inflows. Supporting the authorities’ adjustment program and rebuilding the reserves position requires Fund financing beyond normal access levels.

Criterion 2—A rigorous and systematic analysis indicates that there is a high probability that the member’s public debt is sustainable in the medium term (Appendix Tables I.1–I.2).

Preliminary calculations by staff indicate that there is a high probability that debt will remain sustainable. Belarus’s public debt—about 14 percent of GDP in 2008—is low. Furthermore, curtailed access to debt financing and the expected adjustment in the current account would help maintain public debt at sustainable levels. Standard tests indicate that Belarus’s debt situation remains manageable even with a further 30 percent depreciation.

Criterion 3—The member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding. Belarus’s primary sources of financing are: access to bilateral loans, access of foreign bank subsidiaries to their parents banks, and FDI. Successful implementation of the program could allow Belarus to gain access to private capital markets, including through the sale of shares of enterprises to be privatized, by the time repurchase obligations to the Fund become due. A structural benchmark aimed at improving the privatization process has been added for the completion of the first review. In addition, the current account adjustment and expected recovery in Belarus’s main trading partners should place the economy on a stronger footing by the end of the SBA.

Criterion 4—The policy program of the member provides a reasonably strong prospect of success, including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment. The policies supported by the SBA suggest a strong prospect for success. The authorities continue to take strong policy measures, including further exchange rate adjustment, and are committed to a balanced budget, which demonstrate the authorities’ commitment and capacity to deliver. Risks to the program and ways in which these risks can be mitigated are discussed in paragraphs 19-21.

Schedule of Purchases Under the Augmented Stand-By Arrangement

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Source: IMF staff calculations.

24. The proposed access is high, but Belarus’s capacity to repay the Fund is adequate (Tables 8–10). The level of Fund credit outstanding (including the requested augmentation) will be almost 48 percent of gross reserves at its peak in 2010. However, Belarus’s relatively low levels of external debt and the absence of outstanding Fund exposure prior to the current SBA mitigate risks to the Fund. Additional comfort stems from the fact that the low levels of public debt reflect the government’s longstanding commitment to macroeconomic stability, reflected in sound fiscal policy.

25. The updated safeguards assessment of the NBRB was completed in May 2009. The assessment found that risks have increased since the voluntary 2004 assessment. The safeguards report recommends: (i) the adoption of a new law that provides operational and financial independence for the NBRB to ensure the effectiveness of the NBRB’s internal and external audit mechanism and the control systems; (ii) special audits of NIR and NDA data to reduce the risk of misreporting; (iii) divestiture of NBRB’s investment in non-financial subsidiaries; and (iv) publication of the audited IFRS financial statements. The NBRB concurred with the assessment’s main findings and recommendations, and is taking concrete steps to address the weaknesses.

IV. Staff Appraisal

26. The program approved in January was strong, but it was quickly overtaken by events. The key measures in the program—the initial devaluation and re-pegging of the rubel to a basket of currencies; the tightening of monetary policy; and the agreements on a balanced budget and wage restraint—have been essential in maintaining stability. Belarus would have been in a much worse position without them. But the beneficial effects of these policies have been reduced by a sharp fall in external demand and by cross-currency movements which damaged competitiveness and made it difficult to establish exchange rate stability.

27. The authorities were sometimes hesitant in responding to shocks, but have also demonstrated their commitment to the program in difficult circumstances. The authorities’ initial reactions to the external shock—allowing exchange rate appreciation within the band while they were losing reserves, and delaying adjustment to falling external demand by allowing inventory accumulation—were less than assured. However, they have shown resolve in ensuring that the fiscal and NDA targets were met, have been receptive to staff advice, and recently have shown a strong capacity to adjust their policies.

28. The authorities’ adjustment strategy, based on using all policy instruments to reduce the financing gap, is well founded. The authorities could have chosen a different policy mix, for example one which placed less reliance on fiscal adjustment and involved a larger adjustment in the exchange rate. However, they took the view that both the balanced budget and continuity in the exchange rate regime were important for public confidence. Having chosen this strategy, they have been prepared to undertake the adjustment needed in each of the policy areas to make the strategy a success.

29. In addition to the traditional instruments of adjustment, authorities’ strategy includes stepped-up efforts towards liberalizing the economy and preparing for privatization. The authorities have already lessened the extent of price controls and restrained their involvement in the functioning of the financial system. More efforts are planned—the authorities’ plan to set up a privatization agency is an important step forward.

30. Strong implementation of policies will now be essential. The authorities must be prepared to use the flexibility that their exchange rate regime permits to the extent necessary to protect reserves. They must resist the temptation to reduce interest rates before confidence in the currency has been established. They must be prepared to keep credit and expenditure tight even if there is domestic pressure to loosen policies prematurely. The reward for such consistency will be greater credibility, and greater freedom of action in macroeconomic policy over the longer term.

31. Serious risks remain, but there are also encouraging signs. It is notable that many of the risks identified when the program was approved have materialized—including sharp cross-currency movements and a sharper slowdown in Belarus’s major trading partners. These risks remain, although they seem to have receded recently. The greatest risk to the program is now likely to be inconsistent policy implementation. The authorities’ desire to mitigate the worst consequences of the global crisis on their businesses and workers is clear. But they need to be careful not to use mechanisms which will add to problems instead of solving them. In this regard, the authorities should limit their use of subsidized lending, which has significant budgetary costs and could crowd out lending at market rates. On the other hand, the intensification of privatization efforts offers the prospect of improvements to productivity in enterprises that are privatized and in enterprises whose managers are preparing for privatization, and of improvements in the balance of payments from higher foreign direct investment. It is important that the authorities follow through on their intentions to pursue this and other structural reforms. The upcoming Article IV Consultation, which will coincide with the second program review, will have a special focus on structural reform.

32. The staff supports the authorities’ request for completion of the first review under the Stand-By Arrangement and for an augmentation of the arrangement. The staff also supports the authorities’ request for a waiver of the end-March NIR performance criterion and for modification of the end-June performance criteria. The staff welcomes the authorities’ renewed commitment to exchange rate flexibility and monetary tightening, their continued commitment to fiscal adjustment, and their willingness to deepen structural reform policies. The staff believes that completion of the first review and augmentation of the arrangement by $1 billion is warranted given the increase in the financing gap and the strong efforts the authorities are making to solve their problems.

Table 1.

Belarus: Selected Economic Indicators, 2007–14

(Adjustment Scenario)

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Sources: Belarusian authorities; and IMF staff estimates.

Contribution to growth.

Gross consolidated debt of the public sector (central bank and general government debt including publicly guaranteed debt).

Table 2.

Belarus: Balance of Payments, 2007–14

(Adjustment Scenario)

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Table 2.

Belarus: Balance of Payments, 2007–14 1/(concluded)

(Adjustment Scenario)

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Sources: Belarus authorities; and IMF staff estimations.

Includes projections of unaccounted flows of $250 million for 2009 onwards. Previously, recorded under errors and omissions.

In 2009, Russia’s budget support of $1 billion is included as other donors’ financing in the program column, but as government loan in the projection column.

Table 3.

Belarus: Fiscal Indicators and Projections, 2007–10

(Adjustment scenario; trillions of Belarusian rubels, unless otherwise indicated)

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Table 3.

Belarus: Fiscal Indicators and Projections, 2007–10 1/(concluded)

(Adjustment scenario; percent of GDP, unless otherwise indicated)

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Sources: Ministry of Finance; SPF; and IMF staff estimates.

Includes changes in expenditure arrears.

The 2009 projection excludes project financing attracted before the approval of the program, which was not included in the financing projections.

The actual deficits 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 includes January closing expenditure in the year they were actually paid.

Includes statistical discrepancy up to 2008.