Public Information Notice No. 02/10

Public Information Notice: IMF Concludes 2001 Article IV Consultation with the Republic of Belarus

February 19, 2002

On January 23, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Belarus.¹

Background

During the past year the authorities made headway in further liberalizing the foreign exchange market, stabilizing the exchange rate and reducing inflation; they also took steps to liberalize prices and initiate other structural reforms. At the same time, a policy of raising wages to unaffordable levels during an election year undermined progress achieved in stabilization.

Inflation receded during 2000-01, but economic growth is decelerating. Real GDP grew by 3 percent in January-October 2001, compared to 5 percent during the same period in 2000.² Measured output growth, especially in 2001, masks an underlying weakening of economic activity, as suggested by the rising levels of inventories, noncash transactions, and domestic arrears, the low level of profits and investment, and sagging competitiveness. Year-on-year CPI inflation continued to decline, dropping from 108 percent in December 2000 to 47 percent in October 2001. However, monthly inflation picked up in the second half of 2001, reflecting wage increases, monetary easing and some price liberalization. The external current account improved markedly during 2000-01, turning into a surplus of $240 million (4.5 percent of GDP) at end-June 2001, partly owing to a strong export performance during the first quarter. Gross reserves increased during 2000-01, but still cover less than one month of imports.

Following the exchange rate unification in September 2000, the National Bank of Belarus (NBB) shifted to a crawling band exchange rate system, with the Belarusian rubel/Russian ruble exchange rate as the nominal anchor. Several liberalization measures led to further deepening of the foreign exchange market. Consequently, the Republic of Belarus, on November 5, 2001, accepted the obligations of Article VIII, Sections 2, 3, and 4 of the Fund's Articles of Agreement, which ensures convertibility of current account transactions. The exchange rate remained relatively stable during 2001.

Real wages rose steadily during 2000-01. This policy had a negative impact on enterprise profitability, investment, and the budget. After a significant tightening of fiscal policy in 2000, fiscal developments in 2001 were shaped by efforts to cut expenditures to offset increases in budgetary wages. While the consolidated fiscal deficit (cash basis) was limited to 0.6 percent of GDP in 2000, it is projected at around 1.8 percent in 2001. Expenditure arrears started to accumulate since the beginning of the year, particularly at the local government level; tax arrears also gathered pace.

The monetary policy stance was tightened in 2001. Nevertheless, it was more expansionary than envisaged in 2001 due to a jump in cash in circulation and household rubel deposits with banks, following the spring wage hike and enterprises' move to cash settlement. After the exchange unification, some remonetization took place, reflecting increased confidence and the maintenance of positive real interest rates in rubel deposits.

Some steps were made to initiate structural reforms during 2001, but the outstanding agenda remains large. In particular, the authorities made major headway in foreign exchange liberalization and started to dismantle the extensive system of price controls. In addition, a new investment code was adopted in October 2001, providing new safeguards for domestic and foreign investment. A strategy for implementing a targeted social safety net was developed in cooperation with the World Bank. Presidential Decree No. 40, allowing extra judicial confiscation of property, was revoked in November 2001.

Significant progress was achieved under a Staff-Monitored Program (SMP), covering April 1-September 30, 2001. Monetary/exchange rate policy were implemented successfully and the benchmarks for structural reforms were largely met. However, the fiscal program deviated markedly from SMP commitments largely due to expansionary wage policies. As a result, the six-month track record required to initiate discussions on a Stand-By Arrangement was not fulfilled. Nevertheless, the SMP played a positive role in steering economic policies toward macroeconomic stabilization and market reform during the past year.

Executive Board Assessment

Executive Directors were pleased to note that the authorities had made important moves toward sound macroeconomic policies and market reforms. Directors welcomed the positive results that were achieved in price and exchange rate stabilization, and first steps toward phasing out directed credits, improving the business environment, and putting in place a targeted social safety net. They considered that the revocation of Presidential Decree No. 40 was an important signal of the authorities' commitment to structural reforms. Directors particularly welcomed the liberalization of the exchange market and the authorities' acceptance of obligations of Article VIII, Sections 2, 3 and 4 of the Fund's Articles of Agreement, on payments and transfers for current international transactions.

However, Directors expressed concern about the government's approach to wage setting and its macroeconomic implications. They urged the authorities to refrain from setting wage targets in foreign currency terms and cautioned against targeting wages higher than could be afforded on productivity grounds. While the authorities had taken steps to partially offset the impact of the wage increases, their magnitude had been such as to undermine fiscal performance, slow the progress that had been made in lowering inflation, and weaken the fragile enterprise sector. The wage increases could also jeopardize medium-term growth prospects. More generally, Directors urged the authorities to adopt a coherent program of policies designed to lay the foundations for a market economy and macroeconomic stability.

Directors were encouraged by the progress achieved in certain areas under the SMP. The SMP had provided a framework for policy implementation, supported the momentum of reform, and enhanced the credibility of the NBB. They noted that all monetary targets had been achieved and that the measures envisaged in the structural benchmarks had largely been implemented. Directors found it unfortunate, however, that the fiscal program had departed from SMP commitments largely because of the increases in wages that had been granted, and the record of policy implementation had not been fully satisfactory. At the same time, some Directors considered that the overall fiscal effort had been a step in the right direction, and that substantial progress had been made on a number of fronts. Directors encouraged the authorities and the staff to develop a new monitoring framework that could lead to future Fund support. A few Directors could support starting negotiations on a Stand-By Arrangement.

Directors advised the authorities to review their fiscal objectives and policies for 2002 to ensure in particular that the wage bill was consistent with likely productivity developments in the economy. Otherwise there might be a danger of a further buildup of arrears, additional pressure on the budget, enterprises, and banks, and increased expectations of monetary easing. Directors advised the authorities to use the flexibility allowed under the crawling band arrangement to avoid a further erosion in external competitiveness. Directors emphasized, however, that a sound fiscal position was the bedrock of a successful and credible exchange rate policy, and would be an essential condition for any future currency arrangement the authorities might consider. It was also emphasized that the acceleration of structural reforms would contribute significantly to enhancing economic efficiency and external competitiveness.

Directors noted with concern that the downside risks remained large in the medium-term. They underscored that structural imbalances in the real sector would need to be addressed without delay to avoid reversal of the recent progress in stabilization and liberalization. In their view, the reform agenda remained extensive and challenging, and the authorities were urged to complete price liberalization, level the playing field for businesses, accelerate privatization, and reduce government involvement in the economy. Directors expressed concern about the fragile banking sector and agreed that a comprehensive framework for reforming the enterprise and banking sectors was needed. The authorities were urged to adopt anti-money laundering and anti-terrorism financing legislation, as recommended by the IMFC.

Directors regretted that negotiations on a possible track-record SMP for the first half of 2002 had stalled. Directors encouraged the staff and the authorities to resolve their differences of view on the sustainability of the reform program in Belarus, with the objective of restarting discussions on an appropriate macroeconomic framework and a set of reform measures. Sustained progress over an appropriate period of time would be a prerequisite for consideration of the authorities' request for financial support from the Fund. In the meantime, Directors supported continued technical assistance from the Fund to Belarus.

Directors were pleased that the compilation of balance of payments statistics and national accounts had been steadily improving. They regretted, however, that coverage and quality of some basic statistics were still deficient. They highlighted that the coverage of fiscal data would need to be expanded urgently, and with a view to greater transparency, off-budget transactions, such as the Presidential Fund, should be included in the accounts. They added that the new and more accurate method of measuring industrial output should be adopted as soon as possible.