Public Information Notice No. 05/81

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with the Republic of Belarus

June 28, 2005

On June 17, 2005 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Belarus.¹

Belarus experienced strong economic growth in 2004, supported by policies aimed at raising incomes and credit, and a favorable external environment. Inflation was halved during 2004, and slowed down further to 11 percent in April 2005, aided by a balanced budget, exchange rate stability, and continued remonetization on the back of rising trust in banks and the national currency. Inflationary financing of the general government budget from the National Bank was discontinued, and budgetary consolidation progressed further. International reserves have increased, and the government's debt is at a low level. A surge in the current account deficit in late 2004 was largely reversed in early 2005.

However, market-oriented structural reforms have stalled. Privatization has largely ground to a halt and the private sector's share of GDP remains low at around 25 percent. Further, the "golden share" rule has been expanded in 2004, giving government a unique power to intervene in any company which used to have state ownership. The business environment is not conducive to private—including foreign—investment.

While the economy's current momentum is likely to result in significant growth in 2005, its long-term prospects are uncertain in the absence of wide-ranging structural reforms and a phasing out of massive quasi-fiscal activities. Under current policies, growth is expected at 7.1 percent in 2005 and 4 percent in 2006, gradually grinding even lower.

Executive Board Assessment

Executive Directors recognized Belarus's improved macroeconomic performance in recent years and welcomed, in particular, the strong economic growth and reduced inflation realized in 2004. In this regard, they took note of the role played by the balancing of the general government budget, the discontinuation of inflationary financing of the budget, and the exchange rate anchor, as well as demand-inducing policies and advantageous external factors. Directors commended the authorities on the marked improvement in poverty indicators in recent years.

Directors cautioned, however, that Belarus's economy remains vulnerable and that there is a risk that its current strategy would not produce sustainable growth, and observed that continued rapid growth and disinflation would require a tightening of macroeconomic policies and wide-ranging structural reforms to reduce the government's role in the economy and facilitate private sector-led growth. Given the favorable external environment and the economy's current momentum, Directors urged the authorities to take advantage of this window of opportunity to launch reforms and create an environment conducive to private sector growth.

Directors expressed concern about the limited progress made in enterprise and financial sector restructuring. In this regard, they pointed to Belarus's extensive quasi-fiscal operations including, in particular, directed credits and subsidized lending for housing through large state banks. The continued rise in directed credits and subsidized housing loans contributed to escalating liquidity problems in systemically important banks and necessitated another round of government recapitalizations which, as set out in the Financial System Stability Assessment, remain the prerequisite for the continued solvency of Belarus' banking system. In addition, Directors noted with concern the rapid pace of wage increases, which over the past decade outpaced productivity growth and stressed that the enforcement of highly ambitious U.S. dollar wage targets could lead to inflation pressures, enterprise decapitalization, and waning external competitiveness.

Against this background, Directors underscored the need for accelerating the consolidation of quasi-fiscal activities into the budget and at the same time reducing their magnitude in order to safeguard the budget balance. In line with this, while supporting the government's goal of lowering the high tax burden, Directors noted that this would require expenditure cuts. They viewed that given the strong momentum in the economy and the need to keep inflation under control, it would not be appropriate for fiscal policy to provide additional stimulus at this time, despite the easing of the budgetary financing constraint.

Directors agreed that the central bank needed to make low inflation its primary objective and noted that, to this end, the National Bank of Belarus (NBRB) would need to be granted full operational autonomy. They emphasized that while the nominal exchange rate has played a useful anchoring role, further disinflation will require containing credit growth. Directors also saw a need for retaining a measure of exchange rate flexibility to safeguard against excessive real appreciation, to help deal with exogenous shocks, and to allow the NBRB to raise its level of foreign reserves, which remain precariously low, despite a marked increase in the past eight months.

Directors stressed that structural reforms would be key for ensuring growth sustainability by boosting productivity and allocational efficiency. They urged further enterprise reforms and transparent privatization to help harden budget constraints, noting that, together with reduced government intervention in economic activity and a pickup in FDI, this could raise the level of competition and the efficiency of product and labor markets. Directors observed that the resulting increase in productivity growth would provide a sustainable basis for raising income.

Directors warned that the growth contribution of many of the favorable external factors—notably the benefit reaped from Russian energy import pricing—is likely to wane. With rapid growth in neighboring countries, rising incomes and demand for rubels and low external debt, current conditions are conducive to an early transition toward a market economy with minimized costs of policy adjustment. In this regard, Directors stressed that the looming costs of population aging also argued for an early start of reform measures to ensure continued fiscal sustainability.

Directors noted that while Belarus' overall debt ratio remained low, the increasing dependence on short-term liabilities and limited foreign exchange reserves raised roll-over risk. They stressed that Belarus would need to substantially improve the environment for foreign direct investment, not only to help secure a non debt-creating source of financing, but more importantly to facilitate the knowledge and technology transfer that has proven to be a critical contributing factor for rapid productivity growth in most other transition economies. In this regard, they noted that the golden share rule as applied in Belarus was counterproductive and urged its elimination or the limitation of its application—as in other countries—to a handful of preannounced cases that are of central strategic importance.

Directors noted that for the currency union with Russia to prove beneficial for Belarus, a number of key issues needed to be appropriately addressed. While significant further work remains to be done in this regard, prudent macroeconomic policies and an early start on wide-ranging market-oriented structural reforms would increase the likelihood of such an outcome.

Directors welcomed the constructive tenor of the discussions between the staff and the authorities. They commended the authorities for their good track record in implementing technical assistance recommendations and the significant progress made in the past year in this area, marked by the completion of the Financial Sector Assessment Program, the subscription to the Special Data Dissemination Standard, and the publication of fiscal and data Reports on the Observance of Standards and Codes. Directors supported the continuation of technical cooperation with the authorities.