Republic of Belarus: Staff Report for the 2015 Article IV Consultation
Author: International Monetary Fund. European Dept.
Publication Date:
29 May 2015
eISBN:
9781513579863
Language:
English
Keywords:
ISCR; CR; U.S. dollar; market; devaluation; debt; outlay; monetary policy; Belarus economy; current account; broad money
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KEY ISSUES Context: Belarus’ economic model continues to make it highly vulnerable to economic shocks. This was illustrated once more by the turbulence in foreign exchange and debt markets late last year, to which the authorities initially responded with administrative measures before allowing partial exchange rate adjustment. With Russia in recession, a large projected current account deficit, sizable debt repayments, limited market access, and presidential elections in November, risks remain high. Challenges: Further facilitating external adjustment through the implementation of strong and consistent macroeconomic policies. Also, enhancing the market orientation of the economy through bold, frontloaded structural reforms, to bring it on a more sustainable path. Policy recommendations: • Reduce subsidized lending and resist further wage increases this year to contain domestic demand; • Make the exchange rate fully flexible and tighten monetary policy to facilitate orderly external adjustment; • Assess the health of banks and decisively address any uncovered problems including by recapitalizing or resolving undercapitalized banks where necessary; • Remove price controls and mandatory targets for enterprises and devise credible privatization plans to improve resource allocation and raise sustainable growth.

Abstract

KEY ISSUES Context: Belarus’ economic model continues to make it highly vulnerable to economic shocks. This was illustrated once more by the turbulence in foreign exchange and debt markets late last year, to which the authorities initially responded with administrative measures before allowing partial exchange rate adjustment. With Russia in recession, a large projected current account deficit, sizable debt repayments, limited market access, and presidential elections in November, risks remain high. Challenges: Further facilitating external adjustment through the implementation of strong and consistent macroeconomic policies. Also, enhancing the market orientation of the economy through bold, frontloaded structural reforms, to bring it on a more sustainable path. Policy recommendations: • Reduce subsidized lending and resist further wage increases this year to contain domestic demand; • Make the exchange rate fully flexible and tighten monetary policy to facilitate orderly external adjustment; • Assess the health of banks and decisively address any uncovered problems including by recapitalizing or resolving undercapitalized banks where necessary; • Remove price controls and mandatory targets for enterprises and devise credible privatization plans to improve resource allocation and raise sustainable growth.

Context

1. An ineffective economic model and low buffers make Belarus highly vulnerable to shocks. In late 2014, Belarus experienced its third exchange rate crisis since 2008 (Box 1). The recurrent pressures are rooted in the persistent inability of its over-determined central-planning model to deliver sustainable growth. Frequent bouts of expansionary macroeconomic policies, in a context of deep structural rigidities, have fueled inflation and external imbalances and left the country highly dependent on ad hoc external support. Absolute poverty and income inequality are at low levels in Belarus but life expectancy, at 72 years, remains 9 years below the Western European average. Official unemployment is steady and very low at less than 1 percent of the labor force, but there is significant excess employment in state-owned enterprises reflecting deep reluctance to restructure inefficient companies and industries. Inadequate unemployment insurance also deters labor mobility.

Belarus: Recent Exchange Rate Crises

Belarus has experienced two earlier crises in the last six years. Although the specific triggers for each case differed, the macroeconomic vulnerabilities underlying the episodes were broadly the same: high credit growth and wage increases, a tightly managed exchange rate, a large current account deficit, and precariously low levels of international reserves. Recent developments echo many of the elements of the two earlier crisis episodes.

2009—After a decade of strong performance, Belarus was badly hit by the global financial crisis, which revealed long standing vulnerabilities. These included an overvalued currency, an outsize current account deficit, and heavy dependence on Russian energy subsidies. A relaxation of macroeconomic policies in 2008 and a government-driven credit boom exacerbated the situation. External shocks, including a deep recession in Russia, collapsing demand from other trading partners, a steep rise of the REER due to Russian ruble depreciation, and limited access to international credit, led to a precipitous fall in reserves, from already low levels. The situation resulted in an agreement on an exceptional access 15-month Stand-by Arrangement (SBA), aimed at adjusting to the external shocks and addressing Belarus’ most pressing challenges by replenishment of reserves, realignment of the exchange rate, demand management, more robust exchange rate regime and structural reforms.

2011—A sharp loosening of macroeconomic policies following the end of the SBA undid progress and led to another crisis. Stabilization policies, adopted during the 2009–10 Fund supported program, were reversed and substituted with highly expansionary wage and credit policies in an attempt to spur growth. Together with a fixed exchange rate this led to a rapid loss of competitiveness and a sharply widening current account deficit, creating pressures on reserves. Attempts to maintain the peg with administrative controls led to the development of a parallel market where foreign exchange (FX) was traded at a rapidly increasing premium from the official exchange rate. Eventually, the control over the official exchange rate was abandoned, resulting in a devaluation by 65 percent as the official rate was realigned with the parallel rate. Pass-through effects caused a sharp acceleration of inflation to over 100 percent. Growth was anemic in the second half of 2011, and has remained well below pre-crisis levels since then.

Recent Developments

2. Selective policy tightening and a Russian loan helped navigate large external imbalances during much of 2014 (Figures 1–3, Tables 1–2). Following a period of expansionary macroeconomic policies and high wage increases (real wage growth outpaced productivity by a cumulative 30 percent in 2012–14), Belarus started 2014 with a large current account deficit and a tightly-managed currency that was, on staff estimates, substantially overvalued. The National Bank of the Republic of Belarus’ (NBRB’s) crawling peg arrangement—which allowed the rubel to depreciate by 1–1½ percent per month against the U.S. dollar—did little to address these imbalances given persistent double-digit inflation, but a moderation of wage increases and tightening control of credit helped stave off immediate pressures. This was further aided by a recovery of potash exports (after disruptions in 2013), which improved the trade balance, and a US$2 billion bilateral Russian support loan that bolstered reserves.

Figure 1.
Figure 1.

Belarus: Real Sector Developments, 2002–14

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Sources: National Statistical Committee; and IMF staff estimates and calculations.
Figure 2.
Figure 2.

Belarus: External Sector, 2010–15

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Sources: Belstat; National Bank of the Republic of Belarus; Ministry of Finance of the Republic of Belarus; and IMF staff estimates and calculations.
Figure 3.
Figure 3.

Belarus: Inflation and Wage Developments, 2012–14

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Sources: Belstat; National Bank of the Republic of Belarus; and IMF staff estimates and calculations.
Table 1.

Belarus: Selected Economic Indicators (Baseline Scenario), 2011–20

article image
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.

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).

Table 2.

Belarus: Balance of Payments (Baseline Scenario), 2011–201/

(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.

A01ufig01

Trade Balance of Goods

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Source: National Bank of the Republic of Belarus.
A01ufig02

Average Monthly Wages

(Nominal, economy-wide)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Sources: Belarusian authorities; and IMF staff calculations.
A01ufig03

Credit to the Economy

(Trillions of Belarusian Rubles)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

3. Yet the slide of the Russian ruble in the fourth quarter triggered acute pressures. The gradual depreciation of the Russian ruble during the second half of the year steadily increased the overvaluation of the Belarusian currency further but this did not prompt major policy changes. In mid-December, however, when the ruble depreciation accelerated, FX demand soared abruptly, putting heavy pressure on already-low reserves. The weak ruble also prompted a surge of imports from Russia. Bond yields spiked as foreign investors reassessed risks.

A01ufig04

Household FX Deposits

(Percent share)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Source: National Bank of the Republic of Belarus; Bloomberg.
A01ufig05

Annual Yields on Eurobonds

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

4. The initial crisis response centered on heavy-handed administrative measures. The authorities introduced a temporary 30 percent tax on FX purchases, effectively giving rise to a dual exchange rate given the implied wedge between buy and sell rates. A number of banks offered rubel deposit instruments that were indexed to the U.S. dollar rate, which helped stem the deposit outflow to some extent but exposed banks to significant currency risk. The NBRB’s overnight credit rate was hiked from 24 to 50 percent and foreign exchange surrender requirements for exporters were raised. The authorities also introduced a moratorium on consumer price increases that made it illegal for retailers to raise prices, causing product shortages and negatively impacting the viability of retail trade.

5. Eventually substantial adjustment of the exchange rate was allowed. The administrative measures were not sustainable and a parallel FX market quickly developed. Following a high-level reshuffle in the government and NBRB in late December, the NBRB changed course and phased out the FX tax, while stepwise devaluing the rubel by about 30 percent against the dollar. In real effective terms, however, the devaluation only brought the rubel back to the level of the first half of 2014, owing to high inflation, the sharp depreciation of the Russian ruble, and the weakening of the euro. Meanwhile, real GDP grew by about 1½ percent in 2014, primarily driven by the recovery of potash exports, while inflation hovered around 18 percent.

A01ufig06

Exchange Rate Developments

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Sources: INS; and IMF staff estimates.

6. In early 2015, growth slowed sharply though financial markets stabilized. While some tentative measure of stability was regained following the rubel devaluation—with the exchange rate stabilizing and sovereign spreads narrowing—developments in the first months of 2015 were largely negative as high uncertainty, reduced real incomes, remaining administrative measures, and declining trade with Russia weighed on activity. Monthly GDP data show output down 0.6 percent y-o-y in the first two months of the year, led by a 6 percent y-o-y contraction in industrial output. The inflationary impact of the exchange rate depreciation was muted by the ban on price increases—which remained mostly in effect until it was fully lifted in April.

A01ufig07

Contributions to GDP Growth

(Year-on-year, percent)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Sources: Belarusian authorities; NBRB; and IMF staff calculations.
A01ufig08

Inflation

(Y-o-y, percent change)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Outlook and Risks

7. The outlook is for a recession and continued external pressures. With Russia—the largest trading partner—in a deep slump, the Belarusian economy is projected to contract by 2¼ percent in 2015, led by falling exports. While lower oil prices are also a net negative for the Belarus economy (Box 2), ongoing energy subsidies from Russia buffer the shock to domestic demand to some extent. As the room for current account deterioration is limited by external financing constraints and low reserves, further exchange rate adjustment will be required to maintain balance of payments equilibrium. Therefore, an additional 7 percent real effective depreciation is envisaged under the baseline scenario this year, which would allow the authorities to stabilize reserves at a low level of US$2½ billion (less than one month of imports) with a current account deficit of 7 percent of GDP. The rubel depreciation (realized and projected) is expected to fuel inflation, pushing it to 22 percent this year despite weak domestic demand. In the medium term, it is expected that financing constraints continue to force further current account adjustment and gradual exchange rate depreciation, while growth remains weak reflecting structural rigidities.

Belarus: Direct Impact of Lower Oil Prices

The overall direct effect of lower oil prices on Belarus’ economy is negative but modest.

The decline in oil prices has a relatively modest direct effect on Belarus. The direct impact of the recent sharp drop in oil prices on the Belarus economy is modest and estimated to lower 2015 GDP growth by 0–½ percent and to worsen the current account balance by about ¾ percent of GDP. These estimated negative direct effects result on balance from two, largely offsetting, forces:

  • Refining proceeds. Belarus imports crude oil from Russia and re-exports refined oil products to both Russia and to Western Europe. While oil product export prices broadly follow world market prices, import prices of crude are determined by a negotiated formula and are less sensitive to world oil prices—specifically, import prices rise only by about 60 cents for every dollar increase in the world oil price. The substantial decline in world oil prices therefore has a substantial negative impact on Belarus through this channel.

  • Domestic energy use. Belarus is not a producer of oil or gas and is a net importer of oil with some 30 percent of total imports used domestically. The price gain on energy imports for domestic use has a substantial positive impact on the economy.

The indirect impact of the lower oil prices is more substantial. The main impact of low oil prices on Belarus is through their effect on the Russian economy and the Russian ruble exchange rate.

A01ufig09

Oil Export and Import Projections, 2015

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

1/ The oil price was projected at US$96 per barrel in Fall 2014 WEO and US$57 per barrel under the latest WEO assumptions.

8. More external financing could alleviate strains, but prospects are uncertain. The financing outlook is clouded, including on account of spillovers from Russia, which is Belarus’ main source of interbank lending and foreign direct investment (FDI). The Russian government will provide additional support in the form of a waiver to pay duties on re-exports of its oil that was provided at discounted prices. It has also indicated it will refinance debt service due to Russia this year. Further bilateral support could help ease conditions, but there are no concrete indications that more support is forthcoming. The high level of Eurobond spreads following the recent crisis will likely prevent a successful new debt issuance in international markets this year.

Belarus: Financing Requirements, 2013–15

(Millions of U.S. dollars)

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Source: IMF staff calculations.

Includes portfolio, net trade credits and other net investment assets. 2013 and 2014 include errors and omissions.

9. Risks are high and stem from both domestic and regional sources. The main domestic risk stems from the Presidential elections in the fall, which could prompt macroeconomic stimulus measures that would exacerbate inflation pressures and external imbalances. A deterioration of bank balance sheets on account of the sharp rubel depreciation and the weak economic environment is another key domestic risk. Externally, financing shortfalls could deepen the recession or force a sharper exchange rate adjustment. Oil price developments and geopolitical tensions in the region, to the extent that they impact Russia, are also key sources of risks. A deeper-than-envisaged recession in Russia or further ruble depreciation would negatively impact the balance of payments and growth in Belarus. However, better-than-expected Russian growth, or ruble recovery, are upside risks.

Policy Discussions

10. Discussions focused on the need for a decisive reorientation of policies to manage external adjustment and restore stability. Staff and the authorities discussed the need for an exit from remaining administrative crisis measures, paired with comprehensive macroeconomic policy tightening to restore stability. The urgency of long overdue deep structural reforms, needed to bring the economy permanently on a more sustainable path, was also discussed. The staff’s reform scenario illustrates that consistent implementation of such policies would result, after an initial adjustment period, in gradually reducing external imbalances, increasing foreign investment, strengthening reserves, and higher medium-term growth (Figure 4, Table 3).

Figure 4.
Figure 4.

Belarus: Baseline and Adjustment Scenarios, 2013–20

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Sources: Belarusian authorities; and IMF staff estimates and calculations.
Table 3.

Belarus: Selected Economic Indicators (Adjustment Scenario), 2011–20

article image
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.

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).

A. Fiscal Policy: Containing Quasi-Fiscal Operations

11. Quasi-fiscal operations have moderated, but remain key concerns. Large-scale directed and subsidized lending programs continue to be a key feature of the government’s economic policy and boost domestic demand, hamper efficient credit allocation, and create sizable contingent liabilities. Under the government’s “financing plan”—a temporary instrument to prioritize government-funded projects in the face of financing constraints—the volume of new directed lending declined to about 4 percent of GDP in 2014 (from 5 percent of GDP in 2013). At this volume, however, directed lending largely crowded out more viable commercial lending. Pauses in government-led wage increases at the beginning and end of 2014 helped slow economy-wide wage growth, with real wages roughly flat over the full year. While this moderation alone was not sufficient to start making up the competitiveness losses from high wage increases during 2012–13, the more recent exchange rate depreciation implied a more significant correction of Belarusian wages in U.S. dollar terms.

A01ufig10

Directed Lending

(Net flow, percent of GDP)

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

Source: Belarusian authorities; and IMF staff

12. After the headline fiscal balance reached a surplus of 1 percent of GDP in 2014, original plans for a similar surplus in 2015 are being revised in light of weaker growth. Notwithstanding large revenue shortfalls related to weak profit growth and slowing exports, preliminary data indicate that the government over performed its original balanced budget target and ran a 1 percent of GDP surplus in 2014—a result achieved by sharp cuts in expenditures on goods and services and capital investment (Figure 5, Table 4). On staff’s augmented measure of the fiscal balance, which includes off budget quasi-fiscal operations and directed lending, however, a deficit of about 4 percent of GDP remained. For 2015, the official government budget that was adopted in December again aimed at a budget surplus reflecting the intention to save the temporary windfall of an estimated US$700 million that arises this year from Russia’s agreement to waive oil duties. However, in light of the worsening of economic conditions since the budget was passed, the authorities have announced that the budget will be substantially revised. The staff’s augmented measure of the fiscal balance is projected to deteriorate to a deficit of about 7 percent of GDP, mostly on account of expected recapitalization needs of state-owned banks.

Figure 5.
Figure 5.

Belarus: Fiscal Developments, 2008–14

Citation: IMF Staff Country Reports 2015, 136; 10.5089/9781513579863.002.A001

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

Belarus: Fiscal Indicators and Projections (Baseline Scenario), 2011–20

(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 historical averages and assumptions on developments of loan portfolios.

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

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