Belarus was experiencing an economic crisis after the expiration of a Stand-By Arrangement in March 2010. Its policies were loosened significantly, and consequently the account deficit increased and pressure on reserves intensified. The authorities agreed with the Eurasian Economic Community’s Anti-Crisis Fund (ACF), which announced measures including tightening of macroeconomic policies and structural reforms. Executive Directors urged the authorities to restore external stability through further fiscal and monetary policy tightening. Directors stressed that the financial support will require demonstrated commitment to strong policies and structural reforms.
The Belarusian authorities appreciate the useful dialogue with the Fund staff during the First Post-Program Monitoring Discussions. They take note of and thank the staff for the assessment of the current macroeconomic situation and recommendations on economic and financial policies. The authorities express their gratitude for the financial support under the Stand-By Arrangement and for the continued technical assistance provided by the Fund staff during 2009-2011.
Since the completion of the Fund program, the external and domestic environment of the economy of Belarus has continued to be difficult. The price for imported natural gas has been increased continuously from an average US$ 187 per 1,000 cubic meters during 2010 to US$ 223 in Q1 2011 and U$ 244.7 in Q2 2011. It is projected that the natural gas price may further rise to US$ 300 -305 by the end of 2011. The oil supply arrangements continue to adversely affect the effectiveness of the export oriented petrochemical sector. Export markets remain depressed reflecting the sluggish recovery in Belarus’ trade partners. The economic effects of the customs union with Kazakhstan and Russia are yet to be assessed.
As the costs of the decisions taken at the end of last year to stimulate growth and at least maintain the people’s living standard in expectation of better external conditions began to show in February 2011, the authorities took prompt adjustment measures to bring the situation under control. As a result of the fiscal and monetary tightening, industrial production which increased to 15.4 percent in March, has given way to a slowdown since April. In the first quarter of 2011, GDP grew by 10.9 percent compared to the same period in 2010 while for January-July, GDP increased by 8.9 percent.
As the pressure on international reserves increased, the need to adjust the exchange rate became apparent. Mindful of the staff’s recommendation made during the Article IV Consultations to implement a step devaluation, the authorities devalued the rubel which in terms of the currency basket of US dollar, Euro and Russian ruble, depreciated by 65 percent in May, or by about 73.5 percent since the beginning of the year. However, the risks associated with step devaluation, about which the authorities’ expressed their concerns earlier this year, materialized. While competitiveness improved sharply, the devaluation resulted in high inflation, increased dollarization and higher demand for foreign exchange in conditions when no resources were available to cushion these effects. Under these circumstances, temporary administrative measures had to be taken to prevent uncontrollable movements in the exchange market.
In addition to the authorities’ own response to the challenges, external financing of US$ 3 billion was agreed upon under a stabilization program with the Eurasian Economic Community Anti-Crisis Fund, of which US$ 800 million was disbursed in June. While the staff report is rather vague about the substance of the program and considers it “insufficient”, the authorities argue that it is consistent with the Fund’s proposed policies and contains a comprehensive set of policies and key performance indicators to measure progress in stabilizing and subsequently reducing the current account deficit through appropriate adjustments in exchange and interest rate policies, fiscal and monetary tightening, and structural reforms.
The authorities’ policies are geared to substantially correcting the difficult balance of payments’ position. During the first half of 2011, the trade deficit reached US$ 3 billion, or 10.8 percent of GDP. In the same period, the current account deficit reached US$ 5.4 billion or 19.3 percent of GDP. However, adjustment policies are yielding their first results. In May of this year, the trade balance showed a small surplus. In the first six months export growth outpaced import growth by almost 5 percentage points. This trend is expected to further improve with export growth outpacing import growth by 14 percentage points by the end of 2011.
Despite continued shocks and the significant exchange rate adjustment, Belarus’ financial system has remained stable. The share of non-performing loans in total assets at risk was 3.5 percent in 2010 and decreased to 3.2 percent as of August 1, 2011, one of the lowest ratios internationally. The capital adequacy of the banking sector in 2010 was 20.5 percent, substantially above the regulatory minimum of 8 percent. Since January 2011, capital adequacy declined, albeit marginally, to 20.0 percent. Nonetheless, as the staff noted, recapitalization of some banks may be needed. No commercial bank has defaulted or sought restructuring of its liabilities. It appears that there will not be substantial problems with rollovers of banks’ external borrowings either. After the initial outflow of deposits (by 15.6 percent in January-May), confidence in the banking sector is gradually recovering and, since July, household deposits have increased by 8.3 percent for the domestic currency and by 1.8 percent for foreign exchange. No new contracts under the central bank’s “deposit exchange” schemes have been concluded and the authorities are repaying foreign exchange to banks. This, in turn, reduces money supply and tightens monetary conditions.
Fiscal policy will continue to be very disciplined. Budget expenditures will be tightly managed to ensure that the core items are adequately covered and that the social obligations of the state are prudently fulfilled to ensure public support during the period of difficult reforms ahead. The authorities believe that the fiscal surplus of 3.5 percent of GDP in January-July will allow accommodating the legislatively mandated indexation of wages. Wages in the real sector will solely depend on productivity. The authorities will also consider the recapitalization of state-owned banks with due regard to the actual ability of local governments to honor their guarantees to banks and to the fact that lending under government programs will be transferred to the Development Bank. Elimination of cross-subsidization and switching to a fully operational system of targeted social assistance is high on the agenda and the authorities appreciate and rely on the forthcoming Fund technical assistance on these issues.
Appropriate solutions to unifying the exchange rate are expected in early September. The authorities believe that higher proceeds from exports and sale of certain state assets will solidify the foundation for a stable exchange rate environment in the near future. The authorities agree that, after the exchange rate is unified, it will be critical to ensure its long term sustainability. There is an understanding that, in order to achieve this goal, expansionary support of economic growth should be abandoned, the exchange rate regime should have sufficient flexibility, and prudent fiscal and monetary policies should be maintained.
However, the staff suggestion to immediately float the exchange rate without central bank interventions is not without major problems. The staff recognizes that floating the rate will entail a further depreciation. The concern is that, with significant deferred demand for foreign exchange, neither the authorities nor the staff can make reasonable projections of the scope of such depreciation. What is obvious is that, under a completely free floating exchange rate, without sufficient resources to absorb sharp fluctuations, the risks of disruption of production caused by an inflation-depreciation spiral may be not less than the disruption predicted by the staff under the present exchange rate regime.
The authorities’ commitment to economic liberalization, structural reform and promoting private initiative remains unchanged and consistency in implementing reforms should not be doubted. Appropriate regulatory and institutional arrangements have been continuously put in place to improve Belarus’ business environment and to ameliorate conditions for private sector development. According to preliminary information, five more economic liberalization reforms implemented in 2010 and 2011, most notably in taxation, have been recorded in the upcoming World Bank’s Doing Business Report 2012, which allows the authorities to expect a further improvement of Belarus’ ranking. Price controls to address the devaluation aftershock have been lifted. Utilities and transportation tariffs are steadily increased.
Privatization is gathering pace. Creating adequate capacity for the investment and privatization agency may have taken longer than the authorities expected, but building on a firm institutional foundation and appropriate staffing appears to be a reasonable approach. Nevertheless, auctions have been held almost every week since June to offer medium size enterprises owned by the central government in a transparent procedure to local and foreign investors. Investors’ demand remains extremely weak but several benchmark deals have been completed, although so far predominantly with local entrepreneurs. Having been corporatized for the most part, larger state-owned enterprises attempt to tap international capital markets. An initial IPO issue by Belarus’ largest pharmaceutical company fell short of expectations but the management does not consider it unsuccessful and will repeat the issue this fall to pave the way for others as investors’ awareness increases and experience grows.
The Belarusian authorities reiterate their appreciation of the Fund’s assistance and look forward to further dialogue with the Fund, the World Bank and other development partners across the entire spectrum of Belarus’ reform agenda. It is expected that further talks on a possible Fund-assisted program will resume at the time of the Annual Meetings.