Republic of Belarus
2011 Article IV Consultation-Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund
Publication Date:
09 Mar 2011
eISBN:
9781455220007
Language:
English
Keywords:
ISCR; CR; authority; General government balance; Belarusian authorities; government program; broad money; capital adequacy ratio; wage increase; budget deficit; Belurasian authorities
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Belarus’s economy grew rapidly but remained vulnerable to external shocks. Under the IMF-supported program, Belarus avoided loss of output during the global recession, contained inflation, and increased gross reserves. The structural reform agenda focused on economic liberalization, a shift in investment from the housing sector to the tradable sector, a smaller role of the state, and the development of the financial sector. Post-program monitoring was proposed. Establishing a development bank to administer lending under government programs would free the central bank and commercial banks from quasi-fiscal activity.

Abstract

Belarus’s economy grew rapidly but remained vulnerable to external shocks. Under the IMF-supported program, Belarus avoided loss of output during the global recession, contained inflation, and increased gross reserves. The structural reform agenda focused on economic liberalization, a shift in investment from the housing sector to the tradable sector, a smaller role of the state, and the development of the financial sector. Post-program monitoring was proposed. Establishing a development bank to administer lending under government programs would free the central bank and commercial banks from quasi-fiscal activity.

I. A Time of Uncertainty

1. This is a time of political and economic uncertainty for Belarus. President Lukashenko won re-election on December 19. However, reflecting concerns about the conduct of the election and the post-election detention of opposition leaders and supporters, the EU and U.S. have intensified sanctions against Belarus leaders and companies. Agreement has been reached on a Common Economic Area between Belarus, Kazakhstan and Russia, and on new arrangements for importing oil from which Belarus will benefit. Economic policies for the period ahead are supposed to be based on the Program for Social and Economic Development for 2011-15 (the “five-year plan”) approved by the all-Belarusian People’s Congress.1 However, the five-year plan contains multiple and inconsistent objectives, and the authorities must decide what priority to give them. Belarus must also choose between a model based on central planning and one based on free markets—the five-year plan embraces elements of both. More immediately, the authorities must address pressing macroeconomic imbalances created by loose pre-election polices, which are now putting heavy pressure on reserves.

2. This report proposes policies for 2011 and a policy direction for the next five years that would direct Belarus toward prosperity and stability. The staff proposes policies which will promote sustainable growth by liberalizing the economy and rebalancing investment to raise potential growth, and by reducing the size of government and increasing resources available to the private sector through banks. But external stability is a pre–requisite for sustainable growth and the need for adjustment is now urgent. The staff therefore proposes policies that will bring down the current account deficit by containing domestic demand and by greater use of exchange rate flexibility.

II. The Recent History

3. For a decade before the crisis Belarus’s economy grew rapidly, but its vulnerability to external shocks has also increased (Figures 1-5). An average annual growth rate of about 7½ percent consistently surprised observers given continued dominance of the economy by state-owned banks and enterprises (only about 30 percent of GDP comes from the private sector). The rapid growth is best explained by an educated and disciplined workforce and by consistently high rates of investment, made possible by large annual subsidies on energy imports and direct financial support from Russia, which eased the balance of payments constraint on Belarus’s growth. External vulnerability was always theweakness of the Belarus growth model. Throughout the past decade growing exports were offset by imports, keeping the current account deficit high and reserves low. The crisis in 2008-09 led to a sharp drop in exports, and was exacerbated by reduced subsidies on oil and gas exported by Russia to Belarus.

Figure 1.
Figure 1.

Belarus: Performance Among Peers, 2002-09 1/

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: IMF, World Economic Outlook; IMF, International Financial Statistics; and IMF staff calculations.1/ CEE includes Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Rep., Estonia, Hungary, Latvia, Lithuania, Macedonia, Montenegro, Poland, Romania, Serbia, Slovak Rep., and Turkey . CIS includes Russia, Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Rep., Moldova, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. The 5th and 95th percentiles include the entire CEE and CIS samples excluding Belarus.
Figure 2.
Figure 2.

Belarus: Output Developments, 2001-10

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: National Statistical Committee; and IMF staff estimates and calculations.1/ Lagged 12-month moving average of industrial production.
Figure 3.
Figure 3.

Belarus: Inflation Developments, 2008–10

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: National Statistical Committee; and IMF staff estimates and calculations.
Figure 4.
Figure 4.

Belarus: External Developments, 2005–11

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: National Bank of the Republic of Belarus; Bloomberg; and IMF staff estimates and calculations.
Figure 5.
Figure 5.

Belarus: Monetary Developments, 2008–11

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: National Bank of the Republic of Belarus; and IMF staff estimates and calculations.

4. Belarus made progress under the Fund-supported program and resumed fast broad-based growth in 2010, but the current account deficit remains high and reserves low. Through exchange rate depreciation coupled with strong budgetary policies and wage restraint during the SBA which expired in March 2010, Belarus avoided loss of output, contained inflation, and increased gross reserves.2 Belarus achieved growth of about 7½ percent in 2010. The twelve-month CPI inflation was 9.9 percent in December, reflecting strong domestic demand and increasing food prices due to the drought in Russia. The current account deficit was 13 percent of GDP in 2009 and is estimated at 16 percent of GDP in 2010. A debut Eurobond ($1 billion) issuance was more than offset by heavy intervention—gross reserves stood at $5 billion at end-December (1.4 months of imports), whereas net reserves fell by almost $6 billion in 2010.

uA01f0001

Net International Reserves 1/

(Billions of U.S. Dollars)

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: National Bank of the Republic of Belarus and IMF staff estimates1/ All values are shown at current exchange rates. Values for June, September, and December, 2010 are IMF staff estimates

5. A sharp widening of the current account deficit is partially explained by a strong external energy shock, now partly reversed. An oil supply arrangement agreed in January 2010 reduced implicit subsidies from Russia, through a reduction of the discount compared to the Urals oil price from about 30 percent to about 15 percent.3 In addition, as a result of a gradual transition towards market prices, the price of imported natural gas has nearly quadrupled since 2006. As a result, the energy trade balance deteriorated from near balance in 2006 to a deficit of 6.9 percent of GDP in 2009 and further to an estimated 10 percent of GDP in 2010. The new agreement with Russia on the regime for oil imports reached in December 2010 will improve the energy balance (staff estimates by about $1.3 billion or 2 percent of GDP) but does not fundamentally change the outlook (Box 1).

6. Macroeconomic policies also played a significant role in fueling the current account deficit. Following the expiration of the program the authorities focused on increasing growth and on honoring the President’s pledge to increase average wages in the economy to $500 a month by the end of 2010. Problems in controlling government-supported lending for housing, agriculture and other priority sectors had already been evident during the program, and from April 2010 onward such lending increased sharply, resulting in an increase in net lending under government programs (LGP) estimated at four times the annual limit agreed during the program. Twelve-month credit growth was 38 percent in December 2010, compared with 28 percent a year ago. The government increased the first grade budget sector wage by a cumulative 50 percent in 2010 including a 30 percent increase in November, and the Republican budget deficit limit was increased to 3 percent of GDP. The National Bank of the Republic of Belarus (NBRB) reduced policy interest rates and made only limited use of the exchange rate flexibility available to it in the ±10 percent band during 2010. From January 1, 2011, the NBRB recentered the band at its end-2010 level and narrowed it to ±8 percent.

7. The authorities have financed the deficit largely through foreign currency borrowing in international markets and from commercial banks. They placed a debut Eurobond ($1 billion) in the international markets, issued bonds on the Russian market (equivalent to about $250 million) in 2010 and accessed the Eurobond market again in January 2011 ($800 million). More troublingly, during the last quarter of 2010 the NBRB borrowed extensively in foreign exchange from domestic commercial banks in exchange for rubel liquidity at low interest rates via so-called “deposit exchanges”. During all of 2010, the stock of such borrowing amounted to some $3.8 billion, with $2.3 billion having been accumulated in the final quarter of the year.

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Sources: Belurasian authorities, and IMF staff calculations.

8. The NBRB tightened monetary policy somewhat and allowed the rubel to depreciate against the currency basket in early 2011. The NBRB has limited liquidity support to banks, primarily by curtailing non-market transactions, leading to a 400 basis points increase in interbank lending interest rates since end-December. However, this has yet to translate into any significant change in deposit or lending rates. The rubel has depreciated by 2½ percent against the currency basket since end-December, but remains broadly unchanged against the U.S. dollar.

9. The official financial soundness indicators appear adequate (Box 2), but NBRB foreign exchange borrowing from banks poses serious risks for them. The system-wide capital adequacy ratio was reported at 20.5 percent at end-December 2010 following recapitalization of major state-owned banks by 1.3 percent of GDP in 2010. However, LGP continues to put pressure on state-owned banks’ liquidity, and the NBRB increased its claims on banks by nearly 12 percent of GDP in 2010. Banks’ NPL ratio was reported at 3.5 percent, but compliance with the new asset classification standard adopted in 2010 has yet to be verified through on-site inspections, which have not been carried out at major banks since 2008. The rapid growth of bank credit in 2010 is also a source of concern: rapid credit growth has been found to be a leading indicator of a banking crisis in other countries and could threaten asset quality in Belarusian banks. With regard to NBRB foreign currency borrowing from commercial banks, although the NBRB bears the exchange rate risk, the high volume of this borrowing exposes the banks to serious risks, if the NBRB allows reserves to run down.

10. There have been some promising initiatives on structural reform but their implementation has lagged. The approval of amendments to the Privatization Law and the decree on the National Investment and Privatization Agency (NIPA) improved the legal and institutional frameworks for privatization. Presidential Directive “On development ofentrepreneurial initiative and the promotion of business activities in the Republic of Belarus”(President’s Directive) approved in late December, if implemented, would significantly reduce state control over the economy, facilitate private sector development and make Belarus more attractive for investors. The authorities continued price liberalization, as indicated by the elimination of restrictions on setting trade margins, except for socially important goods and those produced by monopolies. The authorities’ decision to set up a Development Bank (essentially a renamed Specialized Financial Agency (SFA)) could make financing of LGPs more transparent, but many details remain to be settled. The NIPA has not been set up and the head of the agency has not yet been selected. The selection of state companies which could be offered for privatization and would be attractive for investors has also not been completed, while those companies which were offered by the authorities for privatization failed to generate investors’ interest.

III. Outlook and Immediate Challenges

11. The staff believes that the authorities’ policies are based on overly optimistic plans and are insufficiently tight. The authorities believe that through a combination of external financing, higher than expected privatization proceeds, and regaining preferential prices for oil in the framework of the CEA they can finance deficits while they increase exports and grow their way out of debt problems. This strategy is reflected in the latest draft five-year plan (Box 3) as well as in the authorities’ plans for 2011: the budget deficit was relaxed to 3 percent of GDP and net LGP is expected to remain at about 6 percent of GDP. The staff believes that the assumptions in the five-year plan are highly optimistic, and the policies proposed for 2011 are too loose. If substantial external financing is available, the authorities’ policies could succeed in the short term—possibly lifting output growth above potential—but Belarus cannot run large current account deficits indefinitely.4

12. The baseline projections, which reveal unsustainably large financing gaps over the medium term, illustrate the staff’s views of the effect of expansionary policies in the absence of significant structural reform. The estimated output growth rate in 2011 is high at about 7 percent, nearly closing the output gap opened up during the crisis, but thereafter Belarus is not able to maintain pre-crisis growth rates without adjustment and structural reform. The baseline projections point to sizeable current account deficits, a decline in identified financing (despite the $800 million Eurobond issue in January and an expected return of FDI inflows to their pre-crisis levels) and, therefore, large financing gaps in 2011 and over the medium term. Debt sustainability analyses (Appendix I) suggest increasing dependence on largely unidentified external financing and a debt path that could eventually become unsustainable. In the absence of significant policy tightening that would lower the current account deficit, gross external debt is expected to reach 75 percent of GDP and public debt to rise to 29 percent in 2016. Financing gaps could be filled by further borrowing or larger than expected FDI inflows over the medium term. Reflecting a projected increase in the share of market-based financing, the average cost of financing is expected to increase from its current low level. This strategy poses significant risks—pressures in European bond markets could reduce availability and increase the cost of external market financing for Belarus further. The authorities broadly agreed with the analysis, but they believe that financing gaps can be filled partly through asset sales, thus reducing accumulation of debt, and that export promotion policies will bring down the current account deficit over the medium term.

13. The staff highlighted the risk that expansionary policies cannot be sustained even in the short term, and hence there is an urgent need for adjustment. If Belarus loses its access to financing, the reserves could be depleted faster than expected. A loss of reserves could lead to the loss of control over the exchange rate and initiate a destabilizing spiral of depreciation and inflation, expose the banking system to risks (especially given the high foreign currency exposure of banks to the NBRB) and disrupt production. To limit the immediate risks the staff recommended tightening fiscal and monetary policies, allowing the exchange rate to depreciate to the bottom of the band, and discontinuing provision of liquidity to banks at non-market terms. The NBRB noted that market purchases of foreign exchange by businesses and households had been lower in January than in December, and therefore concluded that there was no urgent need for a change in policies. The staff stressed the urgency of discontinuing NBRB foreign currency borrowing from commercial banks and bringing reserves up to a more comfortable level by macroeconomic adjustment. The NBRB agreed, and said they would not increase the stock of such borrowing at end-2011, though they might increase borrowing within the year. The staff also recommended that the NBRB refrains from using administrative measures to limit demand for foreign exchange, noting that such measures could distort foreign exchange markets and could lead to exchange restrictions or multiple currency practices. The authorities said that they would be careful not to interfere with importers’ ability to purchase foreign exchange.5

IV. Key Challenges Beyond The Short Term: What Should Belarus’s Economy Look Like in 2015?

14. Discussions on the medium-term outlook and objectives focused on policies required to attain external sustainability, structural reforms needed to improve potential growth, and measures to rebalance growth. Staff and the authorities agreed on the broad medium-term objectives for the economy: (i) external sustainability manifested by a low current account deficit, a lower level of external debt, and a higher reserve cushion, (ii) robust growth based on improved competitiveness, (iii) a much higher share of the private sector in the economy, supported by a steady increase of FDI and less overall government intervention. There was also some common ground on structural reforms to increase the role of the private sector. However, the authorities also thought that increasing investment to promote exports and import substitution were needed to bring down the current account deficit. Staff pointed out the dangers of such directed investment, and suggested that the best means of raising potential growth (by 1-2 percent) would be to improve the environment for private businesses. Staff also underscored the need for urgent macroeconomic adjustment to accompany structural reforms. Staff’s views—elaborated further in selected economic issues papers accompanying this report—and the authorities’ responses are summarized below.

A. Strengthening Policies to Attain External Sustainability

15. Macroeconomic policy adjustment is needed to reduce the current account deficit and reduce the financing gaps present in the baseline scenario. The gas price increase expected in 2011 and relaxation of macroeconomic policies since the end of the program have led to an overvaluation of the REER by 12-16 percent, as estimated by external sustainability and macro balance approaches (Box 4). Staff considered that over the medium term the current account deficit should be lowered to some 3½ percent of GDP, the reserves cushion should be increased to 3-4 months of imports, and external debt should be placed on a sustainable path. The main choice is between an adjustment strategy based on substantial exchange rate depreciation with appropriate supporting policies and a strategy based on substantial tightening of domestic demand, with less need for depreciation. These scenarios reduce but do not eliminate the financing gaps despite somewhat higher FDI inflows over 2012-16. Both of these strategies include structural reform as discussed in the subsequent sections, which increase Belarus’ potential growth over the medium term.

  • An adjustment scenario based mainly on exchange rate flexibility (adjustment scenario 1). This scenario emphasizes exchange rate flexibility, resulting in a sizeable depreciation of the REER in 2011 and 2012, which increases net export contribution to GDP in 2011, 2012 and also 2013 owing to the assumed lagged effect. Tightening of domestic demand policies is also expected to make a significant contribution towards eliminating the REER misalignment: the augmented general government deficit should be tightened from 4.3 percent of GDP in 2010 (including bank recapitalization and payments on government guaranteed debt in the amount of 2.6 percent of GDP) to a balanced budget in 2011, through freezing nominal wages and strictly implementing government plans regarding subsides, capital expenditure and intermediate consumption. Net LGP in 2011 should be limited to 3½ percent of GDP (compared to about 6 percent of GDP in 2010). To improve the effectiveness of monetary policy, provision of liquidity to banks at non-market terms should be discontinued. Finally, the NBRB needs to keep interest rates positive in real terms (and strongly positive for a period) to re-establish confidence in the rubel.

  • An adjustment scenario based mainly on a substantial adjustment of domestic demand (adjustment scenario 2). In this alternative scenario, policies are adjusted to contract real domestic demand by some 3.3 percent in 2011. The fiscal deficit in this scenario would be similar (reaching a balanced budget in 2011), but the policy adjustment needed to achieve it would be greater, because the nominal revenue would be lower and real wages higher. Assumed fiscal policy adjustment includes significant budget expenditure cuts, which would probably require rescinding part of the recent wage increase, additional cuts in subsidies and transfers and expenditure on goods and services, and raising utility tariffs closer to cost recovery levels more rapidly than currently planned. Tight fiscal policy needs to be supported by substantial tightening of credit policy: net LGP would need to be limited to some 1½ percent of GDP. Under this scenario, the exchange rate would depreciate modestly in nominal terms during 2011 using the flexibility provided by the exchange rate band.

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Sources: Belarus ianauthorities: and IMF staffesti mates and calculations.1/ Adjustment scenario 1 is based on exchange rate flexibility with supporting tightfi seal and monetary policy measures. Adjustment scenario2 is based on a substantial adjustment of domestic demand with moderate exchange rate flexibility.

16. The authorities agreed that the current account adjustment is needed urgently but did not like either of the scenarios. The authorities are aware of the risks that they face, but believe that through asset sales and external borrowing they can finance the current account deficit in 2011, and that after that the 5-year plan could deliver external stability and strong growth without the drastic measures proposed by staff. They stressed the political difficulty of reversing, even partially, the recent wage increase. Some policy makers recognized that a more depreciated exchange rate would help restore external balance, but they were concerned that a devaluation would damage confidence and erode their credibility.

17. The staff recommended a strategy based on exchange rate flexibility and eventually inflation targeting, as this best meets both short-term and long-term needs. In the short term, a devaluation would produce a swift improvement in the current account deficit without output loss. Over the longer term, Belarus would benefit from moving to a flexible exchange rate regime supported by inflation targeting. This would make the economy more resilient in the face of external shocks, and help maintain competitiveness. The authorities accepted the desirability of moving toward inflation targeting, but underscored the need for significant improvements in macroeconomic management to normalize the transmission mechanism of monetary policy. Staff and the authorities agreed that significant preparatory work is needed and discussed technical assistance needs in this area. The requirements for a successful launch of an inflation targeting regime are elaborated in an accompanying selected issues paper.6

B. Improving Long-Term Growth Potential through Structural Reforms and Productivity-Enhancing Investment

18. To facilitate private sector development, improve the business environment and attract foreign direct investment Belarus will need to make deep structural reforms in the medium term. Developing a competitive tradable sector would require limiting state intervention in the economy and enhancing market competition. The authorities shared staff’s view that the process of phasing out mandatory quantitative targets, including wage and employment targets, further price liberalization (already begun with World Bank support) and the simplification of the tax system should continue. Moreover, they believe that small and medium enterprises would need to become an engine of economic growth in the medium term. To this end, the President’s Directive envisages measures which would simplify the regulatory system, guarantee property rights and set up a modern dispute resolution system. The Directive, if implemented, would also phase out quantitative targets and the unified wage grading system, eliminate restrictions on trade profit margins, and establish legal presumptions in favor of entrepreneurs in disputes with state agencies.7 An ambitious structural reform agenda would help to address structural balance of payments problems and improve total factor productivity. The authorities agreed that structural reforms are needed but have not yet made final decisions on what changes should be made.

19. Resource constraints in the post-crisis era suggest that Belarus needs to shift investment toward equipment and machinery to strengthen long-term growth potential. Investment has been a main driver of growth in the decade before the crisis, supported by abundant external financing and energy subsidies from Russia. But these sources of finance are now less secure, and recently the government housing program has skewed investment towards structures, crowding out investment in equipment and machinery that promotes productivity growth more than other investment due to the embodied technology.8 These trends should and can be reversed. Tax policy can support investment in equipment and machinery, including by raising depreciation allowances for such investment to bring them to levels comparable to those in other countries. The scale of the government housing program could be brought down to a sustainable level by reducing the targets for housing construction, scaling down the size of subsidies provided by the housing program, and relying more on market-based housing finance and construction. The authorities broadly agreed with the need to rebalance investment away from housing construction, but noted that it would be difficult to retrain and reorient construction workers. The government has already planned to introduce tax reform measures—including new depreciation rules—this year to provide incentives for equipment and machinery investment.

C. Reducing the Fiscal Burden and Curbing Expensive Subsidy Programs

20. The fiscal burden is a constraint on Belarus’s competitiveness and should be reduced. At a level of 44 per cent of GDP in 2010 and subject to significant pressures going forward due to rapid population aging9, the general government expenditure level is not exceptionally high compared to peers. However, it imposes a relatively high tax burden on the business sector.10 Tax reform to attract investment and foster economic growth should be accompanied by reforms on the spending side in order not to widen the budget deficit. In order to prevent future pension system imbalances, the authorities should consider increasing the retirement age and limiting growth of pension benefits, as suggested by the recent TA report on rationalizing expenditures.

21. There are margins to reduce expenditure, starting from the poorly targeted and expensive subsidies programs. Belarus spends about 14 percent of GDP in subsidies. They are meant to reduce the cost of utilities, transportation, housing, and food for the entire population. Therefore they favor disproportionately heavy consumers, which tend to be relatively well-off households.11 Staff recommended reductions of housing, agricultural, and food subsidies, increases in preferential VAT rates, and bringing utilities tariffs close to cost recovery levels. The authorities acknowledged the need to revisit these programs and are now planning an increase in utility tariffs by about 30 percent this year. The authorities and staff agreed that the adjustments should be complemented by expanding the recently established Targeted Social Assistance program.

D. Reforming the Banking Sector to Improve Financial Intermediation

22. Transferring LGP to the Development Bank would be a major step in freeing the NBRB from non-market support to state-owned banks. At present, banks are dependent on liquidity support from the NBRB to finance LGP, and the financial system in general has become a conduit for massive quasi-fiscal activity. The authorities now plan to create a Development Bank instead of the previously planned SFA, though the functions of the Development Bank—to take over part of the stock of LGP and eventually all new LGP—are similar to those of the SFA. Staff reiterated its view that the new institution should be the sole provider of new LGP, with net lending included in the budget above the line.

23. Creating a level playing field and competitive environment in the financial sector will improve allocation of resources. It is crucial that state-owned banks make lending decisions based on commercial considerations. The staff urged the authorities to renew their efforts in privatizing major state-owned banks and to improve their corporate governance and risk management. Development of nonbank financial institutions would offer more choice in savings and insurance instruments for households and businesses. Removing the monopoly on mandatory insurance enjoyed by state-owned companies would promote growth in the insurance sector.

24. The authorities and staff agreed that improvements in banking supervision are needed to maintain soundness of the financial system, including in Anti-Money Laundering and Countering the Financing of Terrorism (AML/CFT). The recent IMF TA mission on banking supervision found that the supervisory approach at the NBRB remains mostly compliance-based. Staff and the authorities agreed on the need for a peripatetic advisor to help the NBRB in strengthening banking supervision by shifting to risk-based framework and discussed TA options in this area. Staff also recommended excluding banking supervision from the Presidential Decree #510 to allow supervisors schedule bank examinations as they deem necessary.12

V. Relationship with the Fund

25. A review of SBA performance was conducted in the framework of Ex Post Evaluation of Exceptional Access (EPE). The review concluded that the program was generally successful, and most program conditions were met. It notes that problems experienced under the program reflected external shocks but also rapid directed lending, and warns that the structural reform agenda remains largely unfinished and that macroeconomic vulnerabilities remain in the wake of the program. The report highlights the importance of incorporating fully ownership, including at the highest levels, in program design and conditionality.

26. The Fund staff will remain closely engaged with Belarus either in the context of a potential new program, if the authorities decide to request it, or through post program monitoring. Staff emphasized that any follow-up program would need to focus on both structural reforms and macroeconomic measures sufficient to produce a sustainable current account balance and reaching understandings on a set of these policies would be a prerequisite for such a program. The Extended Fund Facility could be an appropriate instrument to support strong macroeconomic adjustment and extensive structural reforms. In the meantime, staff recommends the initiation of post-program monitoring. Belarus’ capacity to repay remains sufficient, although a large projected increase in external debt and growing reliance on expensive market-based financing indicate the presence of significant risks.

VI. Staff Appraisal

27. Belarus made good progress in establishing the conditions for sustainable growth during the program. Through strong economic policies during the SBA which expired in March 2010, and with substantial external financial support, especially from the Fund, Belarus was able to stabilize output, contain inflation, and increase gross reserves. The current account deficit remained too high (worsened by energy price increases and by overly expansionary credit policy) but policies adopted under the program gave Belarus the tools to reduce it, including a more flexible exchange rate system. Progress was made in price liberalization and in the design of institutional frameworks for financial sector reform and privatization.

28. Since March 2010 policies have been loosened to the extent of becoming unsustainable and jeopardizing external stability. The authorities’ decision to pursue over-ambitious growth and wage targets in the remainder of 2010 has left Belarus more vulnerable. They succeeded in increasing growth from 4 percent projected by staff in March to about 7½ percent, but at the cost of an estimated further increase in the current account deficit to about 16 percent of GDP. The government wage increase in November 2010 contributed to inflationary pressures and further eroded competitiveness. The five-year plan promises more of the same: high growth rates to be achieved through credit expansion, including an ambitious housing construction program which crowds out more productive investment.

29. The NBRB’s extensive recourse to foreign currency borrowing from domestic commercial banks is deeply troubling. This borrowing enabled the NBRB to maintain gross reserves and avoid an exchange rate crisis in the run up to the December Presidential election. But the result is that any significant further intervention would bring the level of gross reserves below the level of the NBRB’s liabilities to domestic commercial banks, raising questions about the NBRB’s ability to repay.

30. The authorities need to make quickly some difficult decisions to restore external stability. The authorities demonstrated in 2009 that they have the capacity to adjust when they need to. A similar resolve will be needed in 2011 and the coming years to produce a swift and decisive reduction in the current account deficit and reduce external vulnerability.Fiscal and monetary policy tightening will be needed under any scenario, and bringing lending under government programs under control remains a priority. There are different options available to the authorities on the exchange rate: the staff has a strong preference for using devaluation to reduce the current account deficit quickly with somewhat less domestic adjustment, especially given the urgent need to build up foreign exchange reserves. Continued use of exchange rate flexibility and an eventual move to inflation targeting is also appropriate for a country as subject to external shocks as Belarus.

31. The decisions that the authorities make on the direction of structural reform will be important for Belarus’s medium-term prospects. The latest five-year plan contains many positive elements, including a welcome emphasis on attracting foreign direct investment, and the President’s Directive can almost be read as a bill of rights for entrepreneurs. But the five-year plan also contains retrograde elements, including proposals for import substitution that risk repeating some of the worst mistakes made by other countries in the past. The staff has laid out an agenda for reform, supported by previous analysis during the program and new analysis in the selected issues papers. The agenda includes economic liberalization, a shift in investment strategy, reducing the footprint of the state, and financial sector development. The authorities are interested in this agenda, but still attach priority to policy levers that they can control directly, some of which are inconsistent with a more market-oriented approach.

32. The Fund can support Belarus through policy advice and, if requested, through financial support. Since the last Article IV consultation, the dialogue between the staff and the authorities has been rich, in program reviews, staff visits and jointly organized seminars, which have also included the World Bank. The authorities have not always taken the Fund’s advice, but they have always listened to it. This policy advisory role could be enhanced further under post-program monitoring, which the staff recommends to initiate. Up to now, the authorities have been generous in their praise of the support that the Fund gave them during the crisis, but confident that they can proceed without further financial support from the Fund. However, the staff sees a considerable need for macroeconomic adjustment and for finance to support that adjustment, and Fund support of a program which included sufficiently strong macroeconomic adjustment and market-oriented structural reforms would appear to be warranted.

33. It is proposed that the next Article IV consultation be held on the standard 12-month cycle.

Common Economic Area: Main Goals and Current Status

Agreements with Kazakhstan and Russia on establishment of a Common Economic Area (CEA) were signed in December and ratified by Belarus shortly after that; other CEA members would ratify them by 2012. The goals of the CEA would be (i) to develop common goods and services markets and also common capital and labor markets; (ii) to promote structural reforms; (iii) to ensure greater coordination of fiscal, monetary and exchange rate policies and also customs and tariff policies; and (iv) to create common mechanisms of targeted government support to the economy. The November 2009 agreement on the Customs Union (CU) completed the first stage of development of the CEA.

The CU—already in place—is likely to have only limited implications for the Belarusian economy. The introduction of the common external tariff (CET) on July 1, 2010 did not change significantly Belarus’s trade regime and therefore would not affect Belarus’s trade with non-member countries. Almost 75 percent of tariff lines were harmonized with Russia before the CET was introduced, while sensitive goods remain exempted from a CET. Kazakhstan did not have free trade with Russia or Belarus before joining the CU, which could affect trade patterns within the union.

The introduction of the CEA could have broader consequences for Belarus. The legal foundation of the CEA comprises 17 agreements covering various areas, including macroeconomic policy coordination, energy sector development, labor market issues, capital and financial market development, competition and industrial policy, government procurement, environmental regulation and policies, and intellectual property rights. The agreement on macroeconomic policy coordination envisages close consultations among the members on policy issues and sets indicative targets for the general government deficit and public debt, which should not exceed 3 percent of GDP and 50 percent of GDP, respectively, while the inflation differential in members’ economies should be kept within 5 percentage points. The members also agreed to ensure current and capital convertibility of their currencies and expand their use in settlements. Greater integration with Russia and Kazakhstan could benefit Belarus by energizing market reforms and economic restructuring and providing access to a greater market. However, it would also require legal, institutional and policy harmonization in many areas which could potentially result in some loss of autonomy in policy making.

Belarus will benefit from lower oil import prices within the CEA. All trade restrictions, including export duties on oil were eliminated from January 1, 2011, after Belarus ratified CEA agreements. The agreement allows Belarus to import oil from Russia duty free, implying a discount equivalent to about half the world price. In exchange, Belarus will transfer export duties imposed on petroleum products produced from duty-free oil to the Russian budget. Belarus would benefit from the substantial difference between the discount and the export duties on refined products. However, the actual gain is likely to be smaller due to a higher premium on the price of oil imports paid to Russian oil companies: in January this was set at $46 per ton, compared with $11 per ton prior to the new agreement. The premium may be changed, but if it remains at the January level, the net gain to Belarus from the oil agreement will be about $1.3 billion in 2011, or 2 percent of GDP.13

Banking System Stress Tests

According to the stress tests results, the banking system can withstand a variety of single shocks, but state-owned banks are vulnerable to a combined shock scenario with their capital adequacy ratio falling below the 8 percent threshold in this case. The banking system remains sufficiently capitalized under different scenarios, but is most exposed to a credit risk event (15 percent increase in the share of the problem assets) when the system-wide capital adequacy ratio drops to 12.7 percent. State-owned banks are particularly vulnerable to a combined shock scenario (increase in problem assets, depreciation of rubel and increase in interest rates) with their capital adequacy ratio falling to 7.4 percent, below the required 8 percent in this case.

Support from the NBRB has considerably improved the liquidity position of state-owned banks compared to late 2009. The extension of maturity on some NBRB refinancing and opening of long-term credit lines at end-2009 significantly improved liquidity at state-owned banks. Their current liquidity ratio remains above the 70 percent threshold under stress test assumptions (20 percent withdrawal in clients’ liabilities and 50 percent withdrawal in nonresidents’ liabilities). Foreign and medium-sized banks are more vulnerable to a shock from withdrawal of nonresidents’ liabilities, with their current liquidity ratios falling below 70 percent in this scenario.

Stress Testing Results

(Based on end-July, 2010 data)

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Source: National Bank of the Republic of Belarus.

The current liquidity ratio is the ratio of assets with a remaining maturity of less than one month to liabilities with a remaining maturity of less than one month.

Program for Social and Economic Development of Belarus in 2011-15

The Program for Social and Economic Development for 2011-15 (the “five-year plan”) sets bold targets and calls for ambitious reforms but does not address macroeconomic imbalances.

Structural reforms would enhance the economy’s potential, if supported by macroeconomic adjustment, but some measures could result in waste. Deregulation, institution building and developing market incentives envisaged under the five-year plan are critical for private sector development, although macroeconomic instability could undermine the impact of these reforms. The program of export promotion and import substitution through economic modernization and developing new industries could result in developing sectors which are not consistent with Belarus’s comparative advantage.

The plan is not grounded in a coherent macroeconomic framework. Projections of GDP growth significantly exceed Belarus’s growth potential. Achieving rapid growth through credit expansion, fiscal easing and boosting household incomes would undermine external adjustment. The new Prime Minister has proposed that the plan be revised with a view of strengthening measures which would narrow the current account deficit.

Achieving the social goals of the five-year plan is unlikely and would be costly. Households’ incomes are set to increase by 70-76 percent over five years in 2015 (Table below). The five-year plan envisages further significant wage and pension increases and the continuation of government support for housing construction and a subsidization of household utility tariffs, albeit at a diminishing rate.

Main Economic Targets for 2011-15

(Change in percent, unless otherwise indicated)

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Source: Program for Social and Economic Development of Belarus in 2011-15.

Exchange Rate Assessment

Past improvements in price and cost competitiveness contributed to a recovery of export volumes in 2010, but these improvements are likely to have recently leveled off. Following a significant improvement in early 2009, competitiveness was supported during the crisis period by relatively moderate inflation and wage growth, as well as gradual depreciation of the nominal exchange rate. As a result, and boosted further by renewed momentum in potassium markets, year-on-year growth in non-energy export volume turned positive and increased significantly in 2010. However, several factors, including large wage increases and loose macroeconomic policies fueling future inflation towards the end of 2010, are likely to weigh on competitiveness looking forward.

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REER

(2005=100)

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: Belarjsian authorities; OECDr and IMF staff estimates and calculations.

The current account deficit remains persistently high and external vulnerabilities are on the rise. The current account deficit increased further during the crisis period reflecting increases in energy prices and macroeconomic policies aimed at boosting domestic demand. As a result, and despite more dynamic exports, goods trade continues to show a large deficit. Recent intensification in vulnerabilities is reflected in falling international reserves despite significant recourse to external financing.

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Current Account Components

(Percent of GDP)

Citation: IMF Staff Country Reports 2011, 066; 10.5089/9781455220007.002.A001

Sources: Belarjsian authorities: and IMF staff estimates.

Two forward-looking approaches—the macroeconomic balance and the external sustainability approach—both point to significant real effective exchange rate (REER) overvaluation.14 Based on the two approaches, the sustainable deficit level (the current account norm) is estimated to be about 3.5 percent of GDP. Based on current policies, the medium-term current account deficit is expected to amount to 9.4 percent of GDP in 2016, suggesting that the REER is overvalued by about 12 to 16 percent. While these approaches provide useful quantitative estimates of misalignment, they should be interpreted with some caution. Uncertainty about effectiveness of exchange rate adjustment is particularly high in the case of Belarus: the economy is characterized by significant state control and rigidities that dampen the role of price signals, relative to a market based economy. This assessment nevertheless suggests that further depreciation of the nominal exchange rate is needed. The size of the nominal exchange rate adjustment depends crucially on the strength of other macroeconomic policies.

Authorities views. Authorities disagreed with the staff’s assessment that the rubel is significantly overvalued, arguing that structural reforms to increase competitiveness would boost exports and policies aimed at import substitution would dampen imports, resulting in a lower current account deficit over the medium term.

Table 1.

Belarus: Selected Economic Indicators (Baseline scenario), 2008-16

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Sources: Belarusian authorities; and IMF staff estimates.

Contribution to growth.

The high growth in 2010 is due primarily to the increase of NBRB’s FX liabilities to commercial banks. The NBRB is currently revising the methodology of compiling the monetary base: the FX deposits will be removed from the monetary base.

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

The reduction in government saving and a corresponding increase in nongovernment saving in 2010 include bank recapitalization and layouts related to public guaranteed debt in amount of 2.5 percent of GDP performed in 2010.

Refers to the augmented balance of the general government shown in Table 3.

Refers to the augmented expenditure of the general government.

Table 2.

Belarus: Balance of Payments, 2008-16

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Sources: Belarus authorities; and IMF staff estimations.

Values for 2011-16 include transfer of export duty on oil products to the Russian budget.

Includes 2009 SDR allocation.

Reserve targets for 2011-16 are set relative to months of imports.

Based on latest projection available.

Table 3.

Belarus: Fiscal Indicators and Projections, 2008-16

(Trillions of Belarusian rubels, unless otherwise indicated)

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

Includes changes in expenditure arrears.

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 deficits include January closing expenditure in the year they were actually paid.

Includes unidentified financing that is assumed to be filled by government borrowing from abroad.

Includes statistical discrepancy up to 2008.

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