Monetary Union Between Belarus and Russia: An IMF Perspective
IMF News, September 2, 2003
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Bibliographic details
- Published: September 2, 2003
Introduction and context
- Paper prepared for delivery at Belarusian State Economic University; speech available in Russian.
- Author: Director, European II Department, International Monetary Fund; delivered in Minsk, Belarus on September 2, 2003.
- Current plans (as understood by the IMF staff): the Belarusian rubel will be pegged to the Russian ruble next year, and Belarusian rubels will be exchanged for Russian rubles beginning in early 2005.
- The IMF assessment: on economic grounds alone it is not really possible to say whether Belarus will benefit; the union offers substantial benefits and significant risks.
High-level conclusions (overview)
- First: both advantages and disadvantages exist; structural differences between the two economies matter; ultimate decision likely political rather than purely economic.
- Second: risks exist with any exchange rate peg—some fixed regimes have done well (example: Hong Kong), others poorly (example: Argentina).
- Third: making a currency union successful requires a package of very strong fiscal policies and structural reforms in Belarus; most changes needed are those the IMF has long recommended.
- Fourth: joining a currency union does not end relations with the IMF; members of currency unions continue to be IMF members with access to advice, technical assistance, and possible lending operations.
Potential economic advantages
- Immediate "import" of Russian macroeconomic policy; if credible, Belarus would enjoy much of the positive investor sentiment that applies to Russia.
- Inflation would fall to about half of current levels, contributing to growth via increased private sector investment and access to international capital markets.
- Historical note: Belarus had the highest inflation in the Commonwealth of Independent States (CIS) for five years in a row; in 2001 and 2002, only two CIS countries posted lower growth than Belarus (the Kyrgyz Republic and Uzbekistan).
- Trade stimulus: currency unions empirically often produce significant increases in mutual trade due mainly to reduced transaction costs. Russia already constitutes more than 60 percent of Belarusian trade turnover, so trade creation effects may be less pronounced.
- Reform stimulus: fixed exchange rate regimes require flexible labor and capital markets, an excellent business environment, and very tight fiscal policies; the currency union could provide impetus for liberalization and curtailment of damaging government interventions.
Potential disadvantages and asymmetric risks
- Optimal currency area theory: members should have similar economies affected symmetrically by shocks; Belarus and Russia differ (Russia: extractive industries, oil and natural gas; Belarus: processing industry, transportation, agriculture).
- Loss of monetary policy: Belarus would lose monetary policy tools to cushion asymmetric shocks and would give up seignorage captured by the NBB.
- Labor and goods mobility limits: open borders help, but housing market rigidities and differences in retail trade and distribution systems may limit migration and adjustment.
- Real appreciation risk: the Russian ruble could appreciate in real terms over the medium term due to capital inflows and high oil prices; real appreciation could impose competitive pressure ("Dutch disease") on Belarusian industry. Regions in Russia could rely on fiscal federalism remedies; Belarus could not.
- Financial sector vulnerabilities: state-controlled banks (e.g., BelarusBank and AgropromBank) are regularly instructed to lend to specific sectors at subsidized rates, implying poor loan quality and likely need for recapitalization and restructuring. Under a currency union, financing liquidity needs for financial sector reform would be much more difficult and the NBB would effectively lose lender-of-last-resort capacity.
Risks to the sustainability of the union
- If Belarus enters without adequate fiscal policies and structural reforms, NBB reserves (already extremely low) could be rapidly depleted, potentially leading to catastrophic loss of reserves and dissolution of the currency union.
- An uncoordinated exit from a pegged regime can lead to large output losses and significant social dislocation (Argentina cited as example).
What it will take to make the currency union successful (policy recommendations)
- Macroeconomic policy:
- Pursue very tight fiscal policies—possibly even tighter than traditional IMF advice—given very low reserves and very high taxes.
- Significant reductions in government spending are required, achievable without major cuts in health, education and social spending (though World Bank work suggests potential savings there).
- Suggested spending adjustments: curtail agricultural spending, slow road construction, constrain civil service wage growth, downsize and restructure the housing construction program financed by inflationary direct NBB credit and target housing to the very poorest.
- Tax policy:
- Reducing the tax burden on Belarusian business is welcomed; harmonizing tax treatment throughout the currency union is not absolutely essential. However, high taxation in Belarus would tend to direct investment toward Russia; fiscal adjustment should take place on the expenditure side.
- Structural reforms (selected priority areas):
- Improve the business environment dramatically.
- Sharply curtail subsidies to the agriculture sector.
- Advance energy sector reform, including further increases in cost recovery, especially from the enterprise sector.
- Accelerate privatization and public enterprise reform; improve bankruptcy legislation.
- Tighten financial sector regulation and supervision.
- Reform labor market regulations to ensure adequate flexibility.
- Abandon five-year-plan targets for wage growth in US dollar terms—they are described as unrealistic and destructive of competitiveness.
IMF relations and conditionality considerations
- Joining a currency union does not preclude IMF membership, access to advice, technical assistance, or financial resources.
- A stand-by arrangement with the Fund would require a track record of solid macroeconomic performance consistent with IMF advice; the IMF is not currently in agreement with the macroeconomic policy stance of the Belarus authorities and regrets that inflation has not been brought down more rapidly, supported by tighter fiscal and monetary policies and more aggressive structural reforms.
- The IMF remains ready to consult and provide substantial technical assistance and policy advice on whether and how to enter a currency union.
Closing observations
- The currency union decision involves trade-offs between benefits (lower inflation, greater trade and investment, reform stimulus) and risks (loss of policy tools, exposure to asymmetric shocks, financial-sector vulnerabilities).
- The ultimate decision is likely to be taken on political rather than purely economic grounds.
- The IMF aims to provide unbiased, clear advice drawing on global experience; implementation choices remain with the Belarusian authorities.
Source: Monetary Union Between Belarus and Russia: An IMF Perspective by John Odling-Smee, Director, European II Department, September 2, 2003.