The global financial crisis that erupted in late 2008 had a profound impact on Belarus’s economy. The unprecedented external shock necessitated a strong set of corrective measures, including exchange rate adjustment. This Selected Issues paper analyzes whether the corrective measures in the exchange area are sufficient to restore current account sustainability. It examines various pieces of evidence, including basic indicators of competitiveness as well as the macroeconomic balance and external sustainability approaches. It concludes that the substantial misalignment observed in the end of 2008 has been largely corrected.

Abstract

The global financial crisis that erupted in late 2008 had a profound impact on Belarus’s economy. The unprecedented external shock necessitated a strong set of corrective measures, including exchange rate adjustment. This Selected Issues paper analyzes whether the corrective measures in the exchange area are sufficient to restore current account sustainability. It examines various pieces of evidence, including basic indicators of competitiveness as well as the macroeconomic balance and external sustainability approaches. It concludes that the substantial misalignment observed in the end of 2008 has been largely corrected.

II. Sources of Recent Growth and Prospects for Future Growth1

1. Belarus achieved impressive economic growth in the past decade, averaging 7.5 percent per year. Compared with other CIS countries, growth performance in Belarus has also been less volatile. The benefits from the recent growth appeared to be fairly broadly shared by the population, as the poverty rate declined from 47 percent in 1999 to 6 percent in 2008, and inequality remained moderate. In addition, the country ranked the highest among the CIS countries in the 2008 UNDP human development indices.2

2. However, there have been repeated predictions from outside observers, including the IMF staff,3 that Belarus’s economic model is ultimately unsustainable in the absence of policy adjustment and wide-ranging structural reforms. Given its slow progress in transition to a market economy as indicated in the EBRD’s transition indicators, the growth model in Belarus is sometimes described as a puzzle.

uA02fig01

GDP Growth

(Percent)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: IMF, World Economic Outlook; and IMF staff calculations.
uA02fig02

Belarus Transition Indicators, 2008

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Source: EBRD, Transition Report, 2008.

3. This paper attempts to identify factors underlying Belarus’s remarkable economic growth in recent years, and shed light on how to sustain rapid growth in the post-crisis period. Section A analyzes Belarus’s growth factors from both the supply and demand sides, based on stylized facts. Section B discusses the results of the growth accounting exercise. Section C estimates Belarus’s potential growth in light of some external and domestic constraints on growth. Section D discusses structural reforms that can ease constraints on growth. Section E concludes.

A. Overview of Growth Factors

Supply Side

4. Belarus’s rapid growth can be explained by the growth factors in a standard production function:

  • Capital stock. Belarus inherited a quite valuable capital stock from the former Soviet Union, including assets in the automobile and tractor industries that remain competitive in the CIS market and chemical and oil processing industries that can compete in the European markets. Since independence, Belarus has managed to avoid the large-scale asset stripping that took place in other CIS countries, and has increased its capital stock by keeping high investment ratios.

  • Labor. Belarus has a well-educated and disciplined labor force. Compared with some other CIS countries, labor outflow has been less significant. The economically active population in the country declined slowly between 1995-2005 (0.2 percent annually), but has rebounded since 2005, which may have reflected a reflow of workers seeking job opportunities in a booming economy.

  • Capacity utilization. It appears both capital and labor have been utilized at very high rate, owing in part to ambitious quantitative targeting. The unemployment rate has been consistently low and declining. Capacity has at times been stretched, as indicated by the pick up in inflation since 2007.

  • Productivity. Labor productivity has been growing faster than its CIS peers for most of the period, benefiting from the high quality labor and an increasing capital stock. Improvement in energy efficiency also played an important role in improving total factor productivity.4

Investment Activity, 2001–08

(Percent)

article image
Sources: IMF, World Economic Outlook; and IMF staff calculations.

Includes Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russia, Tajikistan, Ukraine, and Uzbekistan.

uA02fig03

Labor productivity Growth

(Percent)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: IMF, World Economic Outlook; and IMF staff calculations.

Demand Side

5. Belarus has managed to realize its growth potential, thanks to a generally favorable external environment and domestic policies that increased demand for its products. During 2001–04, domestic and external demand contributions to growth were broadly balanced. After 2005, growth was boosted mainly by domestic consumption and investment, and current account balance deteriorated. Belarus was able to fill the gap between saving and investment by tapping external financing, thereby sustaining high growth.

uA02fig04

Contribution to GDP Growth

(Percent)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: State Committee of Statistics; and IMF staff calculations.

Contributions to Growth, 2001–08

(Percent)

article image
Sources: Belstat; and IMF staff calculations.
  • Although the contribution of net exports was mostly negative, the positive influence of gross exports on growth should not be underestimated in the sense that it prevented even larger trade deficit. Exports have benefited from vibrant growth in Russia and the world in general, especially since 2003.5 Belarus enjoys strong integration of production chains with those of the Russian economy, as well as easy access to the Russian market. The boom in Russia created a powerful boost for Belarus’s non-oil exports which were traditionally designed and produced for the Russian markets. Energy subsidies from Russia made Belarus’s oil product exports to Europe more profitable.6 The resulting improvement in terms of trade, which tends to accelerate when world oil price rises, not only contributed to oil trade surpluses in recent years, but also produced income and wealth effects that fueled consumption and investment.

  • Apart from capital expenditure in the budget, state-owned enterprises made substantial investment under government programs. Supported by subsidized lending, household investment in residential apartments is believed to be high.7

  • Government wage and income policy has contributed to buoyant private consumption. Since 2000, the real wage increase on average has surpassed productivity growth.

uA02fig05

Oil Trade

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: IMF, World Economic Outlook; and IMF staff calculations.
uA02fig06

Nonoil Trade

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: IMF, World Economic Outlook; and IMF staff calculations.
uA02fig07

Terms of Trade

(2005=100)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: State Committee of Statistics; and IMF staff calculations.
uA02fig08

Labor Productivity and Wage Growth

(Percent)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: IMF, World Economic Outlook; National Statistical Offices; and IMF staff calculations.

B. Sources of Growth From Production Function Approach

6. The production function approach is often used to assess the sources of economic growth and estimate potential growth. The production function describes a functional relationship between output and factor inputs. Output is at its potential if the rates of capacity utilization are normal, i.e., labor input is consistent with the natural rate of unemployment and technological progress is at its trend level. In a standard Cobb-Douglas production function, output depends on labor, capital, and total factor productivity (TFP):8

Y = A LαKβ

y = a + α l + βk

where Y is real GDP, A is TFP, L is total employment, K is the capital stock, α is the labor elasticity of output, and β is the capital elasticity of output. Variables in lower case are in logs.

7. Neither A nor α and β can be directly observed. Under perfect competition, α corresponds to the share of labor income in GDP. Under the assumption of constant returns to scale,9 α + β = 1, and capital income share β = 1 – α. Substituting these parameters into the production function, a residual can be derived:

Solow residual = y - α l - βk

8. Due to economic cycles, the Solow residual includes the effects of TFP and the cyclical components in actual output. TFP can be derived through filtering or by regression on a set of variables that are sources of TFP growth.

9. For Belarus, the production function is applied to actual data during 1995–2008 to derive TFP. Real GDP and total employment data are from the National Statistical Committee. Capital stock series are constructed using the perpetual inventory method, assuming a constant depreciation rate of 5 percent.10 The labor share α and capital share β are 0.45 and 0.55, respectively.11

10. The result shows that during 2001–08 Belarus registered an average growth rate of 8.3 percent, of which factor accumulation explained about 70 percent, while productivity gains made a smaller but also substantial contribution (23 percent). Within factor accumulation, the growth of capital stock—supported by high investment-to-GDP ratios—played a dominant role since the growth of labor stagnated.

Sources of Economic Growth

(Percent)

article image
Sources: Belarusian authorities; and IMF staff estimates.

Accumulation of labor and capital, using factor shares of 0.45 and 0.55 respectively.

Residual from the growth accounting exercise.

11. Based on the panel on the filtered variables, capital stock growth remained high but exhibited a declining trend, implying a higher investment ratio would be needed to compensate for depreciation and maintain the capital stock growth. TFP growth reached its height during 2002–04, and has been falling since then.

uA02fig09

Capital Growth

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Source: IMF staff estimates.
uA02fig10

TFP Growth

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Source: IMF staff estimates.

C. Prospect for Future Growth

12. Statistical methods are often used to provide a rough estimate of potential output. Estimates based on the Hodrick-Prescott (HP) filter imply an economic overheating in 2008, and that Belarus’s potential growth was as high as 8 percent right before the economic crisis. However, the univariate HP filtering, which assumes that output gaps are zero on average during the period in question, has no economic foundations, and therefore should be interpreted with caution.

uA02fig11

Potential Output and Output Gap

(Trillions of Belarusian rubels)

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: State Committee of Statistics; and IMF staff calculations.

13. In fact, the result may overstate potential growth since some of the factors which have supported recent rapid growth appear temporary (such as energy subsidies from Russia) and others may not be sustainable (savings and investment imbalance as reflected in the continuous current account deficits).

  • Both the GDP levels and potential growth rates of Belarus’s main trading partners are likely to be permanently lower in the aftermath of the most severe financial crisis since World War II, reducing external demand for Belarus’s products.

  • Easy access to the Russian market and financing can no longer be taken for granted, following recent incidents of trade disputes between the two countries and given Russia’s open skepticism about Belarus’s debt repayment capacity.

  • Russia is also phasing out energy subsidies to Belarus for both oil and gas exports (Box 1).12

  • Owing to the global financial crisis, attracting external financing to supplement domestic savings would become more difficult or more costly, especially for emerging economies in Eastern Europe. Without major FDI inflows, shortages in external financing may constrain a growth model that relied on external savings to support the high investment ratio.

  • Domestically, the returns from high investment appear to have diminished, as shown in a rise in the incremental capital-output ratio (ICOR), indicating more investment would be needed to produce an extra unit of output. The recent emphasis on investment in residential construction, which does not contribute directly to building productive capacity, is likely to reduce the investment efficiency further.

  • Like some other countries with aging populations, the labor force is likely to shrink reflecting demographic trends.

uA02fig12

Incremental Capital-Output Ratio 1/

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: Belarusian authorities; and IMF staff estimates.1/ ICOR is calculated by dividing the investment-to-GDP ratio by the rate of GDP growth.

14. The production function approach, which is based on economic theory, makes it possible to estimate potential growth based on estimates on potential employment, capital stock, and productivity growth. To arrive at an estimate of the post-crisis potential growth for Belarus, a few assumptions are made, mostly following recent trends. In particular:

  • Employment growth is assumed to be zero in the medium term, reflecting the declining trend of population, and the fact that unemployment rate is already very low, leaving limited room for reducing it further.

  • Capital stock growth is assumed to fall to about 6.9 percent on average. This reflects the fact that capital stock growth has been slowing down recently despite its high investment ratios.

  • TFP is assumed to grow by 1.9 percent at most, reflecting the trend since 2005, and the declining efficiency of capital investment.

The Impact of Changing Energy Prices on Belarus’s Net Exports

The contribution of Belarus’ oil trade balance to GDP fluctuated with the prices of crude oil and oil products. The net exports of oil, measured as the difference between oil product exports and crude oil imports being processed for exports, increased rapidly during 2005–08, rising from 1 to 3 percent of GDP. The gap between the value of exports and imports widened during this period since crude oil import prices did not rise as rapidly as market prices, reflecting preferential prices received from Russia. The subsidy averaged about 40 percent of the market oil price when prices were rising rapidly. With the recent decline in oil prices, the subsidy declined to about 20 percent of the market oil price.

Looking ahead, the contribution of net oil exports to GDP is expected to return to lower historical levels. As the price of oil has declined from recent highs, net exports will decline to values similar to those during the early 2000s. Negotiations currently underway with Russia may further reduce the subsidy and net export value of oil.

uA02bx01fig01

Oil Sector Developments

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: Belarusian authorities; and IMF staff estimates.

Declining gas subsidies will also negatively impact Belarus’ energy trade balance and its contribution to GDP. The price paid by Belarus for its gas imports has risen at a much slower rate than international gas prices. In 2008, Belarus saved almost $1 billion on gas imports due to the highly subsidized price it paid to Russia. If the subsidy continues to decline, gas imports will place a heavier burden on the energy trade balance and subsequently GDP, as gas imports increased from 2½ to 4½ percent of GDP during 2005-08.

uA02bx01fig02

Gas Sector Developments

Citation: IMF Staff Country Reports 2010, 016; 10.5089/9781451805338.002.A002

Sources: Belarusian authorities; and IMF staff estimates.

15. Based on these assumptions, medium-term potential growth will reach about 5.7 percent. To repeat its growth rate in the past decade (7½ percent per year), an annual average TFP growth rate of 3.7 percent would be required. In the meantime, the results may err on the side of being optimistic, since the external financing constraints following the current financial crisis are expected to reduce further the growth of investment and capital stock.

Sources of Economic Growth

(Percent)

article image
Sources: Belarusian authorities; and IMF staff estimates.

Accumulation of labor and capital, using factor shares of 0.45 and 0.55 respectively.

Residual from the growth accounting exercise.

D. Improving Growth Potential Through Reforms

16. If the demand and supply constraints discussed in Section C are not addressed, potential growth rate in Belarus could be permanently lower than right before the current crisis. The production function approach indicates that significant productivity gains would be necessary to resume high economic growth given the limited scope to increase capital and labor input significantly. Experience in other countries proves that better allocation of resources, more dynamic private sector, and increased use of foreign capital can help boost productivity growth.

17. Given the authorities’ stated preference for the gradualist approach to reforms, China’s experience in economic transformation can provide useful insight. A research on China’s growth performance indicates that while the Chinese economy experienced low productivity growth in the central planning era, productivity became a significant sources of growth since economic reform was introduced in 1978.13 Productivity growth contributed 42 percent of the output growth in the reform period of 1979-94, similar to the contribution of capital.

China: Sources of Economic Growth, 1953–94

(Percent)

article image
Sources: State Bureau of Statistics of China, and various Ministries.

Ratio of input growth, weighted by the corresponding factor income share (labor income share is 0.39 for 1953-78 and 0.45 for 1979-94), to output growth.

Ratio of TFP growth to output growth.

18. Hu and Khan (1996) identified several factors that are related to China’s productivity growth in the reform period: (1) reallocation of labor from traditional agriculture to higher value-added activities such as manufacturing; (2) a dramatic rise of the nonstate sector that faced hard budget constraints and had strong profit incentives; (3) China’s open-door policy and “special economic zones”, which helped attract massive foreign direct investment (FDI); and (4) rapid export growth, which has strong positive correlation with productivity growth in domestic industries based on cross-country studies.

19. For Belarus, the fact that economic transition is still in its early stage augurs well for the potential that can be realized by pursuing market-oriented reforms. Belarus also has an advantage in reinventing its growth model by learning from the experiences and lessons of other countries that have undergone that process. In particular, Belarus has significant room to sustain and boost productivity growth by improving resource allocation and allowing the private sector to play a larger role in production and job creation.

20. To improve resource allocation, state intervention will have to give way to market forces in most areas:

  • Price control needs to be reduced to the minimum so that the price mechanism can help adjust excesses and shortages in the economy.

  • The labor market needs to be developed and wage control liberalized so that the most dynamic factor of production can flow to areas where it is the most efficient. To achieve that, employment targets for individual enterprises should be removed, and managers should have the discretion to set wages in a way that provides incentives to improve labor productivity.

  • Quantitative targets are most useful when the economic structure is relatively simple, and the upstream supply and downstream market are ensured. As Belarus’s economy is getting more sophisticated, it will become increasingly difficult to manage it through central planning. In a new environment where easy market access is no longer guaranteed, setting targets at the macroeconomic and enterprise level would make it difficult for enterprises to react to constantly changing market conditions and reduce incentives to improve profitability, leading to inventory accumulation and waste of resources.

  • The banking system should be allowed to make lending decisions based on the profitability and risks of the projects. Market-oriented credit allocation would help increase productivity, while government intervention in the form of directed or subsidized lending will create distortions, crowding out lending to the private sector, increasing the vulnerability of the banking system, and potentially imposing a heavy burden on the state budget.

21. Cross-country experience also shows that productivity growth will benefit tremendously from the emergence of a strong and vibrant private sector, and that the benefit can be amplified by the involvement of foreign investors. In this regard, an ambitious and transparent privatization agenda that is open to foreign investors would help bring much-needed capital, technology, and management skill. This, combined with a high-quality and better-motivated labor force, holds the promise of greatly increasing total factor productivity. Foreign investment can also help diversify Belarus’s production base and external market, and spread modern business practices to the rest of the economy. Experience in other countries also underscore the importance of setting up the social safety net and retraining facilities—sometimes by using privatization proceeds—to ease the social impact of temporary increase in unemployment and prepare the labor force for new jobs.

E. Concluding Remarks

22. Belarus has managed to maintain high growth rates in the past decade, leveraging its inherent strengths but also benefiting from a favorable external environment. Growth outcomes in recent years have consistently beaten forecasts by outsiders, including projections made by the IMF staff. However, high growth during 2005–08 was propelled mainly by domestic demand, which was possible when external financing was relatively abundant and the widening current account deficits can be financed through external savings. In other words, the analysis underlying the IMF staff’s previous prediction is still relevant, but they underestimated the effects of strong domestic demand on growth in an enabling external environment.

23. The current economic crisis exposed the vulnerability of the economy to external shocks, and prompted a timely reassessment of the growth model prior to the crisis. There is increasing evidence that some of the factors contributing to its remarkable growth record are temporary, and a simple estimate based on the production function approach indicates that the potential growth rate after the crisis is likely to be substantially lower than the pre-crisis period.

24. Belarus can improve total factor productivity by engaging in structural reforms to improve resource allocation and enlarge the private sector. Experience in other counties provides strong evidence that Belarus will be able to resume and sustain high growth rate by pursuing these reforms.

References

  • Hu, Z., and M. Khan, 1996, “Why Is China Growing So Fast?IMF Working Paper, WP/96/75.

  • Konuki, T., 2008, “Estimating Potential Output and the Output Gap in Slovakia,” IMF Working Paper, WP/08/275.

  • Oomes, N., and O. Dynnikova, 2006, “The Utilization-Adjusted Output Gap: Is the Russian Economy Overheating?IMF Working Paper, WP/06/68.

1

Prepared by Shuang Ding, with input from Dmitriy Kovtun, Abdoul Wane, and Pritha Mitra.

2

The Human development index (HDI) looks beyond GDP to a broader definition of well-being. It provides a composite measure of three dimensions of human development: living a long and healthy life (measured by life expectancy), being educated (measured by adult literacy and enrolment at the primary, secondary and tertiary levels), and having a decent standard of living (measured by GDP per capita at purchasing power parity).

3

See Republic of Belarus: Selected Issues, IMF Country Report No. 05/217, June 2005.

4

Supported by government policies, energy intensity, as measured by tons of oil equivalent to produce US$1,000 of GDP adjusted by PPP went down from 0.76 in 1995 to 0.45 in 2004.

5

World GDP growth had been above 3 percent per year since 2003 until the current economic crisis; Russia’s economy grew by 6-8 percent per year during the same period.

6

Until recently, Belarus had been purchasing energy (crude oil and natural gas) from Russia at Russia’s highly subsidized domestic price. The total subsidy on energy imports in recent years is estimated at about $5.9 billion in 2007 and $8.2 billion in 2008. In the absence of these subsidies, energy import costs would have been higher by about 13 percent of GDP in both 2007 and 2008.

7

Preferential loans have been provided to individual citizens since 2000 when the Presidential Decree No. 185 was adopted.

8

TFP is a variable that accounts for effects in total output not caused by inputs. Technology growth and efficiency improvements are regarded as two of the biggest sub-sections of TFP.

9

A doubling of input will lead to a doubling of output.

10

Kt = Kt-1 * (1-δt) + It, where K is capital stock, δ is depreciation rate, and I is investment.

11

Based on data provided by the National Statistical Committee, which are consistent with labor share (0.5) calculated by Oomes and Dynnikova (2006) for Russia, and labor share (0.52) used by Konuki (2008) for Slovakia.

12

Russian firms were exempted from paying Russian export duties on the crude oil they supplied to Belarus until early 2007, when Russia imposed export duties on oil shipped to Belarus, and insisted that Belarus charge its own export duty on refined exports to the West. In 2006, the two country also agreed on a path to bring Belarus’s gas import price to the level Russia charges to its European customers by 2011.

Republic of Belarus: Selected Issues
Author: International Monetary Fund