Public Information Notice No. 04/57

Public Information Notice: IMF Concludes 2004 Article IV Consultation with the Republic of Belarus

May 19, 2004

On May 7, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Belarus.¹

Background

Macroeconomic developments in 2003 were mixed. Although in real terms GDP, industrial production and agriculture all grew by 6.8 percent—according to official data prepared on Belarusian national methodology—growth would be lower on international methodology. Despite high recorded economic growth figures, the financial situation of the industrial sector continues to be difficult, as indicated by high inventory levels and the fact that one third of industry (and 60 percent of agriculture) reported losses in 2003.

Although gradual disinflation continued in 2003, Belarus continues to have the highest inflation in the region. Moreover, core inflation, which excludes the impact of administrative price changes, began to grow more rapidly during the second half, suggesting that the reduction in inflation to 25 percent (December to December) was partly due to administrative measures, such as delayed increases in utilities prices and a narrowing of retail trade mark-ups. Within the authorities' crawling band exchange rate regime, the Belarusian ruble appreciated in real terms against the dollar, but depreciated in real terms against the Russian ruble as well as in real effective terms. Nevertheless, the trade balance has remained weak, in part as a result of higher energy prices (especially for natural gas). International reserves remain very low at about a half-month of imports.

Fiscal policy was fairly tight during 2003, due mainly to limited sources of available financing, such as privatization proceeds. The general government cash deficit is estimated at 1¼ percent of GDP, and budgetary arrears of 0.3 percent were repaid. However, quasi-fiscal activities remained significant, including widespread directed lending through the banking system, energy sector cross-subsidization and ad hoc tax preferences.

However, monetary policy was lax, as rubel broad money and rubel reserve money both grew by more than 70 percent. In particular, inflationary financing from the National Bank of Belarus (NBB) to the government—which will be eliminated in 2004—was expanded very substantially during the last days of the year. Further, a substantial portion of banking system credit was issued under the influence of government or presidential decisions, raising questions about the health of the banking system and the reliability of financial sector vulnerability indicators.

Structural reforms seem to have stalled. Increases in energy sector cost recovery levels and a reduction of the number of activities requiring licenses are welcome. However, privatization has slowed, and the private sector share of GDP remains at around 20 percent. Further, the "golden share" rule—which is unique in Belarus, in that it may be declared after a firm has been privatized—not only remains in place, but has been expanded. The poor business environment, including the golden share, reduces the flow of foreign investment to Belarus and discourages private sector investment.

The outlook for 2004 is uncertain. Under current policies, inflation is expected at around 22 percent, and real GDP growth is likely to slow to about 4¾ percent. However, the external environment—particularly growth in the Baltics and CIS states—is favorable, while on the other hand the era of subsidized deliveries of natural gas from Russia seems to be coming to an end.

Executive Board Assessment

Directors welcomed the achievements of the past year, including strong growth, gradual disinflation, and progress in several areas of structural reform. Nevertheless, they observed that Belarus faces a number of medium term economic challenges, including reducing the size of the government and making further progress toward a market-based economy, private-sector-led economic growth, and macroeconomic stability. Directors stressed that meeting these challenges will require a strengthening of macroeconomic policies and a quickening of the pace of structural reform. Noting that neighboring countries are growing rapidly, external debt is low, and remonetization in Belarus is proceeding well, Directors considered that adjustment costs should be manageable for Belarus at this juncture.

Accordingly, Directors urged the authorities to tighten monetary and fiscal policies in 2004 to further reduce inflation and establish conditions for sustained high growth. Directors considered that a tighter fiscal stance is also warranted by the limited availability of noninflationary financing and the need to bring the size of government to a more manageable level and more in line with that in neighboring countries. They welcomed efforts to reduce the tax burden in 2004, and encouraged further efforts in this direction, but urged that expenditure be cut also to reduce the budget deficit. In this regard, they considered that the planned dollar wage increase in 2004 is likely to adversely affect external competitiveness and public enterprise finances. Directors commended Belarus for achieving relatively good poverty indicators. However, they felt that general government spending, which amounts to nearly half of GDP, could be significantly lowered without undermining the authorities' social objectives.

Directors welcomed the elimination in 2004 of direct financing of the budget deficit by the NBB. At the same time, they advised the authorities to discontinue the practice of directed lending through the banking system to finance quasi-fiscal deficits. They stressed that priority should be given to strengthening the banking system, including through loan-loss provisioning in view of sizeable non-performing loans, better loan classification, and tightened prudential regulations. In this context, they welcomed the forthcoming Financial Sector Assessment Program. They noted that weaknesses in the public enterprise sector are a source of vulnerability in the banking sector, and urged implementation of a comprehensive program of corporate and financial sector reform. This should include privatization or closure of state-owned banks and a strengthening of efforts to combat money laundering and terrorism financing, including through legislation consistent with international standards and the establishment of a well-functioning financial intelligence unit.

Directors recommend that, if the authorities decide to peg the exchange rate, appropriate fiscal policies and structural reforms should be in place. They considered that, with foreign reserves equivalent to only two weeks of imports, a fixed exchange rate would make Belarus vulnerable to external shocks. Needed reforms would include strengthening the legal structure, independence, and auditing and financial reporting of the NBB, as recommended in the safeguards assessment that was undertaken at the request of the authorities. A number of Directors also cautioned against a currency union with Russia before closer macroeconomic convergence is achieved and a firmer commitment is made to move towards market-based policies. Some other Directors emphasized that a currency union would be consistent with Belarus' high degree of economic integration with Russia and could lead to stronger economic policies.

Directors encouraged the authorities to accelerate structural reform—including elimination or modification of the "golden share" rule, which they considered a significant impediment to investment in Belarus. They urged the authorities to make progress with privatization and improve the business environment, particularly by reducing unnecessary inspections and regulation of small and medium-sized enterprises. Directors advised against repeatedly forgiving the debts of the agricultural sector, in order to create incentives for an improvement in the performance of that sector. Directors called for an improvement of fiscal transparency, including by reducing the quasi-fiscal activities of the government, following the recommendations of the fiscal Reports on the Observance of Standards and Codes (ROSC). They also considered trade liberalization to be a priority, given that a number of non-tariff barriers are still in effect.

Directors supported active technical cooperation between the IMF and Belarus, recognizing that Belarus has a generally good record of implementation of technical assistance. They welcomed plans to subscribe to the IMF's Special Data Dissemination Standard, and the authorities' intention to implement the recommendations of the data ROSC. These and other efforts will help improve the quality of Belarusian official statistics.