Republic of Belarus: Staff Report for the 2014 Article IV Consultation
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KEY ISSUESContext: Attempts to boost activity with policy stimulus, in lieu of much-needed structural reform, have failed to raise growth and contributed to large external imbalances. Adverse developments in the region further cloud the outlook. High financing needs and low buffers leave Belarus highly dependent on external financial support. The risk of disorderly adjustment remains high.Challenges: Mitigating immediate risks and facilitating external adjustment through a sharp change in macroeconomic policies. Advancing the transition to a market-based economy to raise sustainable growth.Policy recommendations:• Halt wage increases and reduce subsidized lending to slow demand growth;• Reduce foreign exchange interventions and tighten monetary policy to facilitate external adjustment;• Enhance market orientation of the economy through a rapid phase-out of price controls and mandatory targets and by privatization of state-owned enterprises.

Abstract

KEY ISSUESContext: Attempts to boost activity with policy stimulus, in lieu of much-needed structural reform, have failed to raise growth and contributed to large external imbalances. Adverse developments in the region further cloud the outlook. High financing needs and low buffers leave Belarus highly dependent on external financial support. The risk of disorderly adjustment remains high.Challenges: Mitigating immediate risks and facilitating external adjustment through a sharp change in macroeconomic policies. Advancing the transition to a market-based economy to raise sustainable growth.Policy recommendations:• Halt wage increases and reduce subsidized lending to slow demand growth;• Reduce foreign exchange interventions and tighten monetary policy to facilitate external adjustment;• Enhance market orientation of the economy through a rapid phase-out of price controls and mandatory targets and by privatization of state-owned enterprises.

Context

1. After two crises in four years, growth has slowed amid bouts of external pressures. Following average annual GDP growth of 8 percent during 1997–2008, in the aftermath of the 2008 and 2011 crises growth reached only 1.7 percent in 2012 and 0.9 percent in 2013 reflecting structural limitations of the economy and a weak external environment (Figure 1, Table 1). Repeated attempts by the authorities to boost activity through domestic policy stimulus, while delaying much-needed structural reform, have resulted in rapidly rising external imbalances and recurrent bouts of exchange rate pressures, which have in turn given rise to frequent, though modest, policy shifts in short-term efforts to maintain stability.

Figure 1.
Figure 1.

Belarus: Real Sector Developments, 2002–14

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: National Statistical Committee; and IMF staff estimates and calculations.
Table 1.

Belarus: Selected Economic Indicators (Baseline Scenario), 2011–19

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Sources: Belarusian authorities; and IMF staff estimates.

Contribution to growth.

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 include bank recapitalization and layouts related to public guaranteed debt.

The augmented balance adds to the balance of the general government outlays for banks recapitalizations and related to called guarantees of publicly guaranteed debt.

Net changes in stock at current exchange rate.

Refers to the augmented expenditure of the general government.

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

2. High external financing needs and dwindling buffers leave Belarus highly dependent on external financial support. Without more decisive policy changes to reduce imbalances, and with another year of large external payments ahead, Belarus is highly dependent on external support. Russia has promised $2 billion in loans, but modalities for this support are still being worked out and at the time of this report only $450 million has been disbursed. Meanwhile, the decision on the final $440 million tranche under the program with the Anti Crisis Fund (ACF) of the Eurasian Community has been suspended until the second half of 2014 because of noncompliance with program conditionality. Lack of progress on policies also continues to prevent discussions on a Fund program.

A01ufig01

Gross International Reserves

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Source: National Bank of the Republic of Belarus.

Recent Developments

3. The current account deteriorated sharply in 2013 reflecting expansionary policies and a weakening external environment. After the balance of payments position had improved on temporary factors in 2012 the current account balance worsened rapidly in 2013, reaching a deficit of 10 percent of GDP (Figure 2, Table 2). In part the deterioration reflected slowing growth in Russia, but it was further fueled by rapid wage and directed lending growth—which boosted domestic demand—and an ongoing real appreciation of the exchange rate. A disruption of potash exports compounded the deterioration.

Figure 2.
Figure 2.

Belarus: External Sector, 2010–14

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: Belstat; National Bank of the Republic of Belarus; Ministry of Finance of the Republic of Belarus; and IMF staff estimates and calculations.
Table 2.

Belarus: Balance of Payments (Baseline Scenario), 2011–19 1/

(In millions of U.S. dollars; unless otherwise indicated)

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Sources: Belarus authorities; and IMF staff estimates.

Data compiled based on BPM6.

Values for 2011-19 include transfer of export duty on oil products to the Russian budget.

A01ufig02

Trade Balance of Goods

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Source: National Bank of the Republic of Belarus.

4. As short-term risks increased, policies became more cautious from the second half of 2013. After the summer, when the scale of the current account deterioration became gradually apparent and the demand for dollar deposits rose sharply, the authorities made several policy changes. Specifically, wage increases were paused and the exchange rate was allowed to depreciate somewhat faster. Also, monetary policy was temporarily tightened during July–November, until the NBRB switched to direct control of credit volumes in the last quarter of the year. The latter caused a sharp squeeze in commercial credit, as directed lending continued unabated. The combined measures managed to stem deposit conversions and helped quell exchange market pressure, but they were insufficient to reduce inflation, which has persisted at around 16½ percent (Figure 3).

Figure 3.
Figure 3.

Belarus: Inflation and Wage Developments, 2010–14

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: National Statistical Committee; NBRB and IMF staff estimates and calculations.
A01ufig03

Average Monthly Wages

(Nominal, economy-wide)

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: Belarusian authorities; and IMF staff calculations.
A01ufig04

Credit tothe Economy

(Trillions of Belarusian Rubles)

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

5. Developments in early 2014 were mixed and affected by seasonal factors. The trade balance improved markedly, reaching a small surplus, mainly on a sharp decline in imports. While this improvement appears to large extent a seasonal phenomenon—the trade balance tends to improve sharply in the first quarter to then gradually deteriorate during the year—the turnaround may have been particularly pronounced owing to tight external financing conditions in early 2014. Meanwhile, first quarter growth surprised on the upside (+0.5 percent y-o-y), but this was influenced by a large investment project and unlikely to be sustainable. Policies were on hold in early 2014, with the notable exception of monetary policy which is gradually being loosened. The authorities continue to pursue GDP growth (3.3 percent) and real income (3 percent) targets in 2014, but in contrast to previous years, emphasis on these objectives in policy statements has been muted.

A01ufig05

Contributions to GDP Growth

(Year-on-year, percent)

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: Belarusian authorities; NBRB; and IMF staff calculations.
A01ufig06

Trade Balance (Goods and Services), 2013-14

(Percent of GDP)

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Outlook and Risks

6. The outlook is for continued slow growth and persistent external imbalances. With very weak Russian growth weighing on external demand and with domestic demand slowing, only 0.9 percent GDP growth is expected this year. Thereafter, activity remains constrained by structural deficiencies and structurally reduced growth prospects in Russia, which prompt a downward revision of Belarus’ medium-term growth to about 2¾ percent. Inflation is forecast to remain around 16 percent on rubel depreciation and high inflation expectations. The current account deficit is projected at 8¾ percent of GDP in 2014 on weak external demand, low competitiveness, and a policy mix that continues to be too loose. Going forward, limited financing and increasingly low reserves do not permit such high deficits. Therefore, the staff’s stylized baseline scenario assumes gradual exchange rate depreciation that brings about sufficient current account improvement to prevent full depletion of reserves, but not enough to address imbalances and rebuild buffers. Hence, the baseline scenario implies continued very high vulnerabilities throughout the forecast period. Without the stylized assumptions of the baseline, vulnerabilities and the risk of a disorderly adjustment are even higher.

7. Risks are high and tilted to the downside. The main risks are for further balance of payments deterioration and external financing shortfalls. Ongoing developments in Ukraine also pose risks—notably through their impact on Russia—as does possible protracted slow growth in other trade partners (Box 1). Meanwhile, banking sector risks remain substantial on weak loan portfolios and rapid FX lending growth. On the upside, higher-than-envisaged support from Russia or other donors, or successful privatization of a large Belarusian company could alleviate short-term financing constraints.

Policy Discussions

8. Discussions focused on policies to facilitate external adjustment and mitigate risks. The staff’s adjustment scenario illustrates that consistent implementation of sound macro policies and structural reform—in line with staff recommendations—would allow for a steady reduction of external imbalances, strengthening of reserve buffers, and higher medium-term growth (Figure 4, Table 3). Specifically, improving competitiveness and cautious management of domestic demand should prompt a sustained reversal in the current account, while positive confidence effects from structural reform would attract higher FDI. Under these conditions, reserves could be rebuilt and reach about 4 months of import cover by 2019. As reforms take hold, medium-term, sustainable growth could reach close to 5 percent in an environment of single-digit inflation.

Figure 4.
Figure 4.

Belarus: Baseline and Adjustment Scenarios, 2012–19

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: Belarusian authorities; and IMF staff estimates and calculations.1/ The broadly constant external debt-to-GDP ratio in the baseline scenario is explained by an assumption that the gaps in the balance of payments are financed by drawdown of foreign exchange reserves rather than by external borrowing.
Table 3.

Belarus: Selected Economic Indicators (Adjustment Scenario), 2011–19

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Sources: Belarusian authorities; and IMF staff estimates.

Contribution to growth.

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 include bank recapitalization and layouts related to public guaranteed debt.

The augmented balance adds to the balance of the general government outlays for banks recapitalizations and related to called guarantees of publicly guaranteed debt.

Net changes in stock at current exchange rate.

Refers to the augmented expenditure of the general government.

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

Belarus: Possible Spillovers from Regional Geopolitical Tensions

For now there are no clear spillovers to Belarus from the geopolitical tensions surrounding Russia and Ukraine. However, spillovers may occur through several channels (listed below in approximate order of importance).

  • Russian support. Belarus is highly dependent on Russian support, not only through loans but also via heavily discounted energy prices. It is unclear if the recent changes in Russia’s relationship with Ukraine have implications for Belarus, and if so in what direction (more, or less support).

Energy Support from Russia, 2012-13

(In percent of GDP)

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Sources: NBRB; Belstat; and IMF staff estimates and calculations.
  • Trade. Growth in Russia—the destination of 35 percent of Belarus’ exports—is expected to suffer as a result of sanctions, reduced confidence, and higher interest rates. Ukraine—accounting for 12 percent of Belarus’ exports and a positive bilateral trade balance worth US$2 billion—is also a significant trade partner. It is, however, also a (potential) competitor, including for the transit of Russian gas to Europe, resulting in both up and downside risks from trade linkages.

  • Competitiveness. The Ukrainian hryvnia and Kazakhstani tenge have depreciated sharply and other CIS exchange rates—including the Russian ruble—may be affected thereby weakening Belarus’ competitiveness and further increasing pressures on the rubel.

  • Financial linkages. Subsidiaries of Russian banks account for a quarter of banking sector assets with two Russian subs being among the five largest banks. The Russian subs rely mostly on their parents for funding and capital and any weakening of the parent banks could have substantial spillovers to Belarus. Also, Russia accounts for about 70 percent of foreign direct investment in Belarus and any substantial declines in these flows could significantly affect Belarus’ balance of payments.

A. Fiscal Policy: Containing Lending Programs and Wages to Curb Demand

9. Quasi-fiscal directed lending operations and wage policies continue to be the key fiscal policy concerns.

  • Lending. The flow of new subsidized lending increased 35 percent—reaching 5½ percent of GDP—in 2013, thereby fueling domestic demand, raising the share of subsidized credit in overall lending, and adding to concerns about the efficiency of credit allocation. It also created contingent fiscal liabilities as a likely large share of lending was directed at ailing sectors and enterprises. While new lending has increasingly taken place through the Development Bank (DB), growth of directed lending in state banks also continues to be high, validating concerns that the DB has become an additional source of subsidized credit instead of a consolidating institution as originally envisaged. Faced with increasing financing constraints, for 2014 the authorities have adopted a “Financing Plan” that identifies and sets a binding limit on the combined subsidized lending volumes of the DB and other banks (though it excludes subsidized housing lending). Staff estimates that the plan implies a flow of new directed lending on the order of 3¾ percent of GDP.

A01ufig07

Subsidized Lending Crowds Out Market Lending

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: National Bank of the Republic of Belarus; and IMF staff calculations.
  • Wages. Despite a marked moderation in the second half of the year, average economy-wide wages rose 6 percent in 2013 in real terms, thereby exceeding productivity growth (estimated at 1½ percent) by a large margin. The increases—led by government targets—translated into high consumption growth and a further decline in wage competitiveness (Box 2). For 2014, the authorities are planning a real income increase of 3 percent. However, the real wage increase over January—March (abstracting from the seasonal December spike) amounted already to 4.6 percent, pointing to upside risks to the official objective.

A01ufig08

Unit labor costs, selected trade partners

2010Q1-2013Q4 (index, 2010Q1=100)

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Source: IMF data.

10. Meanwhile, the authorities again aim to balance the headline budget in 2014. The headline budget posted a small surplus in 2013, despite a 2 percent of GDP revenue shortfall that was countered with ad hoc increases in regulated prices and deferral of expenditures on goods and services and public investment. Including contingent liabilities from quasi-fiscal operations, however, staff estimates that the budget was over 6 percent in deficit (Figure 5, Table 4). For 2014, the authorities are aiming again at a balanced headline budget, but risks are on the downside as the erosion of revenues from external trade is likely structural owing to tariff reductions in the context of the Eurasian customs union and declining exports on reduced external competitiveness.

Figure 5.
Figure 5.

Belarus: Fiscal Developments, 2008–13

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

Sources: Ministry of Finance of the Republic of Belarus; and IMF staff estimates and calculations.
Table 4.

Belarus: Fiscal Indicators and Projections (Baseline Scenario), 2011–19

(Percent of annual GDP, unless otherwise indicated)

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

Includes changes in expenditure arrears.

The augmented balance adds to the balance of the general government outlays for banks recapitalizations and outlays related to called guarantees of publicly guaranteed debt. Projected bank recapitalization costs over the medium term are based on 2008-11 historical average.

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

Net changes in stock at current exchange rate.

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

Belarus. Wage Setting: The Role of the Government

Closer inspection of the role of targets suggests a large role for the government in setting wages.

Rapid economy-wide wage growth has been a key destabilizing factor in recent years. High wage increases—which far outstripped productivity growth—led to overheating, fueled inflation and external imbalances, and reduced competitiveness, and were a key contributing factor to the 2009 and 2011 crises.

A01ufig09
Source: Belstat. Targets for 2001, 2002, 2004, 2005 and 2010 are from official plans, targets for 2006, 2007, 2008 and 2012 are from authorities’ press statements.Note: Productivity is computed as GDP at constant prices in billion rubles/ employment. USD wage refers to the average economy-wide monthly wage measured in USD.

High wage growth in Belarus is not spontaneous but prompted by government policy through widely-applied wage targets.

  • Economy-wide wage targets in US dollars, and corresponding regional and town-level targets in local currency, have been set by the authorities in most years and apply to the entire economy, including the private sector (companies less than 50 percent state-owned).

  • Although the importance of mandatory wage targets appears to be decreasing, the targets have been closely adhered to and are a more important driver of wages than the government’s single pay grading system, which regulates wage-setting in budgetary organizations. Very low variation of wages between regions and sectors confirms the strong influence of official wage targets.

A01ufig10
Sources: Belstat; and IMF staff calculations.1/ Wage targets from annual plans.2/ Both series exclude Minsk city for consistency as no targets were set for Minsk city in 2008-2010.

Policy Discussion

11. Staff urged a sharper reduction of subsidized lending and a halt to wage increases. Staff welcomed the authorities’ Financing Plan, which promises to be a helpful instrument in the control of overall directed lending volumes, and recommended that it become a recurring feature of the authorities’ policy framework. At the same time, given the associated cyclical and structural drawbacks, it urged the authorities to be more ambitious in scaling back directed credit and to limit new lending to 2 percent of GDP in 2014, fully channeled via the DB. Directed lending should be reduced further to 1 percent of GDP in 2015, with a view to a full phase out over the medium term. Staff also recommended forgoing the wage increases embedded in the official policy plans for 2014. Keeping wages constant in nominal terms would avoid fueling domestic demand growth and help make up for lost competitiveness from the excessively high wage growth of recent years.

12. If directed lending and wages are not adequately contained, fiscal balance objectives should be more ambitious. Staff advised that the authorities run a corresponding surplus for any new subsidized lending above the recommended 2 percent of GDP limit, to offset the expansionary effect of such excess lending and help build fiscal buffers to cope with implied contingent liabilities. Staff also urged the authorities to optimize fiscal savings from wages and reductions in subsidies, instead of balancing the budget by reducing capital expenditure. Such savings would also pay for improvements in social safety nets that should accompany reform.

13. The authorities argued that policies were already tightening and that scope for more ambitious cutbacks was limited. They suggested that given wage hikes in recent years, which had resulted in a large increase in average wage levels, the emphasis on meeting wage targets would be less pronounced this year. In addition, financing constraints would limit the scope for directed lending. In this context, the authorities explained that the Financing Plan was a temporary instrument aimed at ensuring sufficient financing for ongoing projects deemed critical, at the expense of lower-priority and new projects. Meanwhile, the authorities were planning to make the DB the main coordinator of all directed lending from 2015—an initiative that was welcomed by staff in principle although its modalities remain largely unclear. Regarding the headline fiscal balance, the authorities worried that achieving even the zero balance mandated by the budget would prove to be an uphill struggle if revenue performance continued to be weak. Further cuts in capital expenditure would be considered, but there was a considerable chance that a deficit would result.

B. Monetary Policy: Reducing External Imbalances and Inflation

14. Despite high risks to stability, the NBRB is relaxing monetary policy. Monetary policy effectiveness remains constrained by a suboptimal operational framework and the disruptive impact of subsidized lending. However, domestic interest rates have a direct impact on the population’s willingness to hold local currency. Therefore, in response to the pickup in demand for foreign currency deposits last summer, the NBRB increased the reserve requirement for foreign exchange deposits and raised the overnight credit rate by 10 percentage points to 45 percent (Figure 6, Tables 5 and 6). From November, however, the NBRB has started to loosen policy again by reversing the reserve requirement and cutting the overnight credit rate. In addition, in April and May, the NBRB also lowered the refinancing rate by two percentage points to 21.5 percent and put regulatory caps on the interest rates banks can charge their clients. The policy loosening risks reigniting exchange rate pressures in the context of large external imbalances and continued high inflation.

Figure 6.
Figure 6.

Belarus: Monetary Developments, 2011–14

Citation: IMF Staff Country Reports 2014, 226; 10.5089/9781498383356.002.A001

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

Belarus: General Government Accounts, GFSM2001 Presentation, 2011–13 1/

(Percent of GDP)

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Source: Belarusian authorities.

The GFSM presentation includes a very small amount of non-budgeted expenditures and revenues. These items include incidental sales and associated expenditures from non-market institutions.

Table 6.

Belarus: Monetary Authorities’ Accounts (Baseline Scenario), 2011–19

(Trillions of Belarusian rubels, unless otherwise indicated; end-of-period)

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