Belarus -- 2004 Article IV Consultation, Concluding Statement of the IMF mission
February 9, 2004
Belarus―2004 Article IV Consultation
Concluding Statement of the mission
February 9, 2004
Belarus has chosen a slow path of economic reforms because the authorities believe that in this way social costs can be avoided in the transition to a market economy. While this objective is laudable, the mission believes that gradualism is contributing to weak economic performance, and will lead to lower growth and living standards in the long run. Gradual progress with disinflation continued in 2003. However, the mission regrets the lack of the realism in the authorities' macroeconomic framework for 2004. The mission recommends more conservative assumptions for growth of real GDP and wages in 2004, and advises tighter fiscal policies and deep structural reforms to lay the foundation for durable economic growth over the medium term.
1. Macroeconomic developments in 2003 were mixed. GDP, industrial production and agriculture all grew by 6.8 percent in real terms according to official data prepared on Belarusian national methodology. However, using international methodology, growth would be lower. The mission welcomes the intention of the authorities to begin publishing national accounts data on international methodology in 2006, but recommends doing so immediately rather than waiting until the end of the five year plan. 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 enterprises reported losses in 2003. (About 60 percent of agricultural enterprises are loss-making.)
2. Although gradual disinflation has 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 weakened somewhat, driven partly by higher energy prices (as Belarus is a net energy importer). International reserves remain very low at about ½ month of imports.
3. 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 1 ¼ 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.
4. Monetary policy was lax in 2003, as rubel broad money and rubel reserve money both grew by more than 70 percent. Although the mission welcomes the elimination of inflationary financing from the NBB to the government in 2004, it regrets the fact that monetary policy was loosened substantially during the last days of2003. As a result, inflation in 2004 will be significantly higher than the authorities project unless they take steps to tighten monetary policy. At the same time, it bears repeating that inflation cannot sustainably be controlled by administrative means.
5. A substantial portion of banking system credit is issued under the influence of government or presidential decisions. These directed credits were to have been eliminated under the 2001 staff monitored program agreed with the IMF staff. They weaken the health of the banking system and raise questions about the reliability of financial sector vulnerability indicators. The mission advises that they should be abolished.
6. Structural reforms seem to have stalled. The mission welcomes increases in energy sector cost recovery levels and reduction of the number of activities requiring licenses. 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 may be expanded. It is clear that the poor business environment, including the golden share, reduces the flow of foreign investment to Belarus and discourages private sector investment.
7. The authorities' macroeconomic projections for 2004 are based on overly optimistic assumptions. While it is natural to hope for extremely rapid economic growth, the mission feels that the authorities would best serve the long run interests of Belarus by basing macroeconomic policies on more realistic assumptions. Targeting real GDP growth of 9-10 percent undermines the integrity of macroeconomic policies when in fact only about half that level can realistically be expected.
8. The mission strongly advises against administrative increases in wages—especially in US dollar terms—that are not backed by growth in productivity. Raising average wages to $175/month will in fact reduce enterprise investment and harm the competitiveness of Belarusian exports. It could also undermine tax payments, including to the Social Protection Fund, thereby leading to an accumulation of arrears on pensions.
9. The mission urges the authorities to consider a tighter fiscal policy stance. Elimination of direct NBB financing of the budget is very welcome, but sources of financing the budget deficit are very limited. Given that Belarus has the highest tax burden in the region, we welcome efforts to reform the Belarusian tax system. However, this suggests a need to undertake corresponding expenditure cuts, including by reducing subsidies to agriculture and industry, and by limiting the government wage bill.
10. On purely economic grounds, the mission continues to feel that it is not possible at present to determine whether or not the proposed currency union with Russia will prove to be beneficial for Belarus in the long run. There are advantages―such as lower transaction costs in trade with Russia―and disadvantages―such as a loss of competitiveness of the Belarusian economy if the Russian ruble continues to appreciate in real terms. Indeed, it seems likely that decisions regarding the currency union will be motivated more by political than by economic considerations. However, the mission notes that either a pegged exchange rate or a currency union would require tighter macroeconomic policies and deep structural reforms of the sort the IMF has long advised to Belarus.
11. The mission urges the authorities to reconsider the macroeconomic framework for 2004. We believe it would be advisable to tighten fiscal and monetary policy in order to achieve more rapid disinflation. As a result, real GDP growth would be about half the authorities' 9-10 percent target, but a slowdown of growth is unavoidable in the short run, if durable long run growth is to be assured.
12. The mission also urges the authorities to accelerate structural reforms to promote growth and competitiveness through development of the private sector. These reforms are essential whether Belarus enters a currency union or not. Priority reforms include:
• Extending energy sector reform by introducing independent regulation and by raising cost recovery levels, and by taking steps to eliminate cross subsidization within industry;
• Redesigning the housing construction program to target needy groups in a more cost-effective manner;
• Undertaking agricultural reform, beginning by eliminating directed commercial bank lending to the sector and by streamlining support from the budget, and by moving to allow private ownership of land;
• Improving labor market flexibility (by liberalizing employment rules and by ceasing to set economy-wide wage targets, especially in US dollar terms);
• Bolstering medium-term fiscal consolidation by beginning the process of civil service and public administration reform, as well as pension system reform;
• Improving public enterprise management, including through further corporatization and development of transparent trust management arrangements;
• Eliminating the "golden share" provision;
• Demonstrating a commitment to full transparency in privatization by using internationally-reputable advisors in preparing large tenders (as in part is being done for Beltransgaz); and
• Taking steps to improve the business climate by ensuring a stable legal environment, limiting ad hoc inspections and regulations, reducing the tax burden, and by developing a timetable to move to International Accounting Standards (IAS).
13. Weaknesses in the banking sector need to be addressed urgently. Although a long- term solution needs to encompass both the corporate and the financial sectors, the mission urges the authorities to tighten prudential regulations and to refrain from all forms of directed lending.
14. The mission takes note of the authorities' decision to withdraw their request for negotiations on a stand-by arrangement. Moving toward a stand-by program would in any case be impossible in the absence of agreement on macroeconomic policies—including revision of the Budget Law and Main Guidelines for Monetary Policy. For the time being, cooperation between the IMF and Belarus will concentrate on economic policy consultations such as this Article IV mission, as well as technical discussions in those areas where the IMF has significant expertise.