IMF Executive Board Concludes 2007 Article IV Consultation with the Republic of BelarusPublic Information Notice (PIN) No. 07/108
August 30, 2007
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On August 24, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Belarus.1
Belarus's centralized economy grew rapidly over the past few years, enhancing social development. The state redistributed large and growing terms-of-trade gains stemming from favorable Russian energy pricing across the economy, boosting domestic demand. With available spare capacities, output expanded rapidly. Belarus's social indicators—notably its equal income distribution, high UN human development index, and improving housing conditions—place it at the top of the Commonwealth of Independent States league tables. A de facto exchange rate peg to the U.S. dollar anchored inflation expectations.
A new energy agreement, however, has abruptly reversed terms-of-trade gains. Belarus now pays Russia twice as much for gas supplies as in 2006 and a fifth more as a share of world market prices for crude oil. This results in an estimated loss of 5½ percent of GDP in 2007, of which about 1½ percentage points could be offset by higher export prices and lower energy intensity of production. Subsequent losses will be smaller, particularly if additional declines in energy intensity occur, but cumulative losses through 2012 may reach 10-15 percent of GDP.
Growth and inflation performance remained favorable but resource constraints may be emerging. Growth accelerated to 9.9 percent in 2006 as rapid real wage gains supported consumption, while state-directed credit boosted investment. However, capacity utilization indicators, labor market data, and strong import demand signal incipient capacity constraints. Decelerating money growth, price controls, and the exchange rate anchor helped slow consumer price inflation to 6.6 percent by end-2006. Twelve-month inflation measured by the Consumer Price Index—limited by tightened price caps—rose only marginally to 7 percent through May 2007, but producer prices increased by 13.5 percent.
The current account swung into deficit, raising reliance on foreign financing. Net export volumes fell sharply, reflecting declining non-oil export market penetration and rising unit labor costs. This pushed the current account from a surplus of 1.6 percent of GDP in 2005 to a deficit of 4.1 percent in 2006. In the first quarter of 2007, the deficit reached 1½ percent of annual GDP compared to a small surplus in the first quarter of 2006. Foreign borrowing is increasing rapidly, raising external debt from its low end-2006 level of 19 percent of GDP. The National Bank of the Republic of Belarus (NBRB) has rebuilt its foreign exchange reserves to around one month of imports by July.
Fiscal prudence was a key component of the policy mix. Monetary conditions were accommodative in 2006, and again from April 2007. Pressure on the peg—owing to concerns over new energy prices—forced the NBRB to raise policy rates in early 2007. But annualized credit growth picked up substantially, exceeding 50 percent in real terms by end-April, financed increasingly through rising foreign borrowing and government deposits in 2007. Directed concessional lending through state-owned banks facilitated by large government deposits, and government-mandated wage increases in excess of productivity at state-owned enterprises continued to provide an underlying expansionary impulse to the economy. However, wage growth has been scaled back in 2007, although not yet commensurately with the economy's permanent income loss. The fiscal stance also turned contractionary as the general government moved from a deficit of 0.6 percent of GDP in 2005 to a surplus of 0.5 percent in 2006. During the first five months of 2007, the surplus reached 1.7 percent of annual GDP. Finally, the government limited the pass-through of higher energy import costs to domestic prices to about 60 percent.
Against this background, staff's assessment is that the real exchange rate has become overvalued by about 10 percent.
Financial soundness indicators appear adequate in the state-dominated banking system. The share of nonperforming loans is small. Banking system net domestic assets—at 20 percent of GDP—remain relatively low and largely short term, with over 80 percent controlled by four large state banks. Their profitability is relatively low, and their recurrent recapitalizations fall short of the long-run costs of directed lending, imperiling their solvency.
Progress with structural reforms has been limited and the state's role in the economy remains dominant. Administrative restrictions on price formation, private sector activity and the movement of labor hamper market flexibility.
Executive Board Assessment
Executive Directors noted Belarus's relatively strong macroeconomic performance in recent years, with rapid growth and declining inflation. While this performance reflected broadly prudent fiscal and monetary policies, and strong partner country growth, Directors stressed that growth through 2006 also owed much to favorable terms for imported energy.
Most Directors emphasized that the outlook going forward was likely to be less favorable, with energy costs rising following the new multi-year energy agreement with Russia and the resulting worsening terms of trade. These Directors stressed that the resulting permanent real income loss would adversely impact growth, inflation, the balance of payments, and the fiscal position, especially in the absence of commensurate policy adjustment and structural reform.
Against this backdrop, Directors welcomed the authorities' initial policy response to the terms-of-trade change, but cautioned that heavy reliance on foreign financing should not substitute for adjustment. They noted that the pass-through of higher energy import prices, the more moderate increase in wages, and—critically—the strong fiscal restraint in evidence to date had helped maintain macroeconomic stability. However, most Directors expressed concern about the incomplete pass-through of energy price increases, the continued rapid growth of credit, and the insistence on official targets that call for substantial fiscal and monetary loosening by year-end. These factors, together with the slow pace of structural reforms, would raise external financing needs, the bulk of which would be debt-creating, thereby escalating macroeconomic risks. Some other Directors, however, saw merit in the authorities' gradual approach to reform, stressing the importance of long-term social and economic stability.
Directors considered that the permanent terms-of-trade shift and the likely lag in the supply response called for early adjustment in the policy mix, including a tighter wage policy. In addition, they urged the authorities to implement market-oriented reforms that would substantially reduce state intervention in the economy.
Directors stressed the importance of tightening the fiscal stance. In particular, Directors encouraged the authorities to press ahead with their plans to limit expenditures and improve the operation of the tax system. Also, subsidies to public enterprises and banks should be reduced and the targeting of social spending should be improved.
Directors welcomed the clarifications in the monetary policy framework envisaged for 2008, but saw continued rapid credit growth as inconsistent with maintaining the exchange rate peg. Directors welcomed the planned shift to a formal peg to the dollar, which would eliminate the divergence between the National Bank of the Republic of Belarus (NBRB)'s de jure and de facto exchange rate targets. They observed, however, that to maintain the peg, credit growth needed to be slowed, notably through a phase-out of directed lending. In addition, most Directors noted the deteriorating current account position and the erosion of the economy's competitiveness, as unit labor costs had risen substantially, export market shares in the CIS had decreased, and on the staff's calculations, the real exchange rate had appreciated significantly. Looking ahead, a number of Directors advised the authorities to consider creating the preconditions for greater exchange rate flexibility over time.
Directors commended the NBRB on the progress in strengthening the supervisory framework. However, they emphasized that against the backdrop of continued rapid credit growth, the NBRB needed to remain vigilant in strictly enforcing prudential requirements. Directors welcomed recent steps toward attracting strategic foreign investors to the banking system, stressing the importance of transparent and competitive privatization procedures.