November 28, 2018
PRESS OFFICER: Olga Stankova
Phone: +1 202 623-7100Email: MEDIA@IMF.org
An IMF staff team led by Mr. Jacques Miniane visited Belarus from November 5-15 to hold the 2018 Article IV Consultation discussions.
Belarus continues to enjoy a solid recovery from the 2014-16 downturn, providing a favorable backdrop for the authorities to tackle economic vulnerabilities and boost potential growth. Gradual fiscal consolidation, including by eliminating off-budget debt-creating activities, would help reverse the upward trajectory of public debt and reduce financing needs. The operational independence of the central bank should be preserved, with monetary policy geared toward maintaining low and stable inflation; efforts should continue to address remaining financial sector distortions and to reduce dollarization. While some progress has been made in addressing inefficient SOEs and developing the private sector, more ambitious reforms are needed given the scope of the problems. Risks ahead remain elevated in view of a challenging external environment, though a successful outcome of the bilateral negotiations over losses related to Russia’s tax maneuver would help mitigate them.
Context, Outlook, and Risks
Belarus is in the midst of a solid cyclical recovery. Strong external demand, higher international prices for some of Belarus’ key exports, and rapid wage increases beyond productivity growth continue to support the expansion. At this rate, the economy is on path to grow by 3.7 percent this year, up from 2.4 percent in 2017. Despite stronger exports, the current account deficit is expected to widen to 2½ percent of GDP as buoyant domestic demand and the ramp up in construction of the nuclear power plant stimulate imports. Encouragingly, inflation remains at historic lows and in line with the National Bank’s target. The exchange rate has also been relatively stable.
Stronger macro policies have contributed to the recovery. Following the 2014-15 crisis, the authorities embarked on fiscal tightening, including structural fiscal measures such as pension reform. In addition, monetary policy was overhauled, with a clearer focus on price stability, better defined and communicated policy targets, and greater operational independence for the central bank.
However, medium term prospects remain subdued absent stronger reform efforts. Trend growth in Belarus has slowed down considerably relative to the pre-2008 period. Although the state-led economic system has delivered on full employment, it has also resulted in a misallocation of labor and capital and weaker productivity. Given these trends, we project medium term growth of around 2 percent, below what is needed to raise living standards measurably and for Belarus to converge to its richer regional peers.
In addition, entrenched macro vulnerabilities leave the economy exposed to changes in the external environment. Limited trade and financing diversification makes Belarus susceptible to shocks to a narrow range of goods and partners. In this context, any intensification of global geopolitical tensions could find Belarus in the crosshairs given its deep trade and financial links to Russia. In addition, the country remains dependent on large energy discounts and transfers from Russia, and the outcome of bilateral negotiations on compensation for the tax maneuver will have an important bearing on the economy. In the financial sector, high dollarization creates both liquidity and credit risks, partly mitigated by the banks’ prudent levels of capital at present. Finally, public debt has grown considerably over the last ten years, not least because the high share of debt in foreign currency makes debt sensitive to exchange rate depreciation.
Macroeconomic Policies
Fiscal policy
The 2018 budget deficit is expected to widen as robust revenue outturns are being outweighed by a rapid increase in expenditures. Strong external and domestic demand are boosting budget revenues, which could increase significantly as a percent of GDP this year. Expenditures, however, are rising faster, not least spending on wages and salaries. The overall budget deficit (IMF definition, including spending on SOE recapitalization/debt forgiveness) could reach 1½ percent of GDP this year versus 0.3 percent of GDP in 2017. The deterioration in the deficit is unwarranted in a context of strong economic recovery.
The 2019 budget deficit is expected to widen further. Given that negotiations on the tax maneuver may not be finalized until early next year, the authorities have prudently assumed a worst-case scenario of no compensation in the draft budget. But this together with sizable spending increases, imply that next year’s overall budget deficit (IMF definition) could reach close to 4 percent of GDP. After 2019, deficits should come down as the construction of the nuclear power plant is wound down. However, even conditional on full compensation for tax maneuver losses in 2020 and beyond (as the authorities expect), and assuming no major changes in the exchange rate, public debt including guarantees is expected to increase considerably and stabilize at slightly less than 60 percent of GDP in the medium term.
In the view of Fund staff, Belarus would be well served by some additional fiscal adjustment to put public debt on a firm downward trajectory. Reaching a 50 percent of GDP debt target in the medium term, an anchor which the Fund has recommended in the past, would require a permanent adjustment of about 2 percent of GDP, which could be spread over three years. This should be accompanied by efforts to durably reduce off-budget activities that add to debt, such as recapitalization of or debt forgiveness to SOEs. In addition, nominal growth in wages and salaries could be kept broadly in line with inflation for two years, following the run up seen this year. Revenue-increasing options include reducing VAT exemptions and other tax expenditures.
Monetary and financial sector policies
The National Bank should maintain its current monetary policy stance. With inflation stabilizing in the 5–6 percent range, the current interbank target implies real policy rates of about 4–5 percent. This is appropriate, as the pressures on inflation from rapidly growing wages may not have fully materialized yet. In addition, the volatile environment warrants erring on the side of caution.
In addition, the central bank should continue its preparations for transitioning to inflation targeting. Important strides have been made since 2015 towards a more predictable, rules-based monetary policy. To entrench these gains, we support the central bank’s goal of further progress towards full inflation targeting, albeit with realism given high dollarization and a legacy of fiscal dominance. Efforts made to reduce directed lending and to liberalize the FX market are welcome and consistent with this goal; it is now time to address other important distortions such as interest rate caps, which are inconsistent with the monetary policy framework and distort saving and lending decisions.
The policy independence of the central bank should continue to be respected and even deepened. Increasing independence has been as important to the success of disinflation efforts and to the relative stability of the currency as any improvement to the policy framework.
The authorities have taken some important steps to address concerns about asset quality. Asset quality reviews have been completed for all banks and followed in some cases with demands on remedial actions, which have strengthened capital positions. Going forward, the authorities are encouraged to address the outstanding FSAP recommendations and to continue to strengthen the regulatory and supervisory frameworks.
Further reducing high dollarization is paramount to mitigate financial sector risks. This is, rightly so, a key objective for the central bank. Recognizing that durably reducing dollarization is a multi-year process, the authorities should continue to rebuild trust in the ruble by maintaining prudent macro policies. Prudential regulations should continue to differentiate the higher risks posed by FX deposits and FX lending. Going forward, the ruble capital market will need to be deepened to accompany these de-dollarization efforts. Plans to do so jointly with the EBRD are welcome, including developing the legal infrastructure for derivatives markets. Public communication of the general strategy followed could reinforce the effectiveness of ongoing efforts.
Structural policies
The authorities are taking some steps toward reforming inefficient SOEs, as they recognize that loss-making SOEs are a drag on the economy and the budget . Several pilot projects for restructuring and possible entry of strategic investors are being pursued with EBRD and World Bank support. Plans are also under preparation for the sale of minority shares in non-strategic enterprises. The scope of directed lending is falling, thus reducing an unfair advantage provided to these companies. And efforts are afoot to set up a proper distressed assets market, starting with the important fact that companies and creditors are now legally allowed to sell an asset at a discount. This being said, the distressed assets market should not be limited to a few, pre-approved participants, else market liquidity would be limited and price discovery for the assets compromised.
Nevertheless, a more ambitious reform effort is warranted given that inefficient SOEs lie at the heart of many of the economy’s weaknesses. In particular:
· There should be a systematic, risk-based assessment of SOEs, ideally with help of external consultants, with the goal of triaging SOEs into those that are viable, those that are viable with restructuring, and those that are not viable. Information now systematically collected at the Ministry of Finance would help guide the initial identification of where the main risks lie, and an action plan should be developed to guide the restructuring efforts. Social safety nets should be bolstered to buffer the transitional impact on employment.
· The governance of SOEs should be strengthened, along two lines. First, the ownership and regulatory functions need to be more clearly separated, to avoid conflicts of interest. Second, fit and proper criteria for the selection of Supervisory Board members should be more transparent and follow best practice, while these boards should have independent authority and accountability to guide the companies.
· The devolution of non-strategic SOEs to regional and local administrations should be reversed, as this is transferring weak SOEs to administrations with limited funds and capacity to manage them, and weak incentives to restructure them.
Government efforts to expand private sector activity should be supported but also expanded. The mostly private IT sector is an undeniable success story for Belarus. Beyond IT, we are encouraged by ongoing and planned reforms to improve the business environment. Important priorities include strengthening property rights, streamlining unnecessary regulations and curtailing excessive inspections. The overarching goal of these reforms should be to level the playing field between private and state-owned enterprises in all sectors.
Cross subsidization of energy should be phased out as it increases costs and hurts firms’ competitiveness. In this regard, household utility tariffs should be raised to cost recovery within three years, complemented by expanded and better targeted subsidies to shield the impact on low income and most vulnerable households. Current plans to increase prices would make too gradual a dent on the problem.
Contingency policies
Although the government sees a low probability of less than full compensation for the tax maneuver losses, contingency plans would be helpful if such an event were to materialize. In such an event, oil refining activity would be reduced, dampening export revenue and growth. Tax revenues would also be hit due to lower economic activity, lower transfers from Russia, and lower customs duties. The policy response should aim to mitigate the impact on the balance of payments and facilitate the reallocation of resources in the economy, including:
The IMF mission wishes to express its gratitude to the authorities for their cooperation, hospitality, and candid discussions.
