Background

Belarus had experienced rapid growth in the ten years up to 2008, benefiting from export price gains, strong growth in trading partners, and large energy subsidies from Russia. The reversal of these factors in the course of 2008 put Belarus in a highly vulnerable position at the outset of the global economic crisis, and an IMF-supported program was approved in early 2009 to facilitate adjustment to external shocks and reduce vulnerability.

Belarus has so far escaped a significant fall in output, despite a sharp fall in external demand. GDP declined 0.5 percent year-on-year in the first eight months of 2009, comparing favorably to Belarus’s main trading partners. Economic activity has been bolstered by strong domestic demand, especially housing construction financed under government programs. Twelve-month CPI inflation fell to 12.5 percent in August, as the impact of the negative output gap eclipsed the effects of exchange rate depreciation and utility price adjustment early in the year.

The current account deficit has widened, reflecting weak external demand as well as terms of trade losses. The deficit was partially offset by net financial inflows, including privatization proceeds, trade credits, and government borrowing. Currency substitution, which accounted for large reserve loss at the beginning of the year, came to a halt in early June and has been partially reversed since. Gross international reserves have begun to recover after falling below US$3 billion in late August, boosted by the recent allocations of Special Drawing Rights.

Fiscal adjustment remains strong and on track, with further revenue shortfalls being offset by spending restraint. The effects of the crisis continue to be felt, especially through lower profit tax and excise revenue. The authorities have responded with cuts in expenditures for goods and services and “other expenditures”.

However, lending under government programs continued to increase at a high rate. In the first half of 2009, gross disbursements under government programs were some 40 percent higher than in the corresponding period of 2008. The share of such lending in overall credit to economy increased from 33 percent in December 2008 to 38 percent in July 2009. This lending helped propel high rates of investment and domestic demand and therefore contributed to the loss of reserves. Banks’ involvement in such lending increased their vulnerability to liquidity risks although financial soundness indicators remain broadly satisfactory.

Executive Board Assessment

Executive Directors observed that Belarus had managed to avoid a severe output contraction, with real GDP declining only marginally despite a sharp fall in external demand for its exports. The Fund-supported program has contributed to this cushioning of the output decline. The prospects for high, sustainable growth over the long term will depend critically on the depth and the pace of market-oriented structural reforms.

Directors noted with concern the continued high current account deficit and the lower reserve level, which were due in part to the aggressive expansion of credit under government programs. They encouraged the authorities to phase out gradually central bank liquidity support to banks on non-market terms under these programs and to address vulnerabilities in state-owned banks. Directors agreed that priority should be given to the objectives of building reserves and supporting the exchange rate regime, and therefore endorsed the authorities’ plan to restrain credit for the remainder of the year, accompanied by strong fiscal and monetary policies. In this context, Directors supported the intention to maintain high interest rates until there is clear evidence of a turnaround in reserves and a well-established process of de-dollarization.

Directors applauded the authorities’ commitment to a tight fiscal policy, with revenue shortfalls being offset by spending restraint while protecting priority social spending. The decision to postpone the increase in public sector wages and to increase charges for transportation and utilities would help rein in spending. Directors considered that limiting the consolidated budget deficit to the equivalent of 1.7 percent of GDP in 2010 provides a strong basis for a macroeconomic framework consistent with the objectives of increasing reserves and containing inflation.

Directors noted the staff assessment that the real effective exchange rate and exchange rate regime appear to be broadly appropriate based on agreed tight domestic policies. They generally supported the recommendation to permit more flexibility within the widened band as needed to ensure that the target for international reserves is met. Over the medium term, consideration could be given to moving toward a more flexible exchange rate regime.

Directors welcomed progress on financial sector reforms, including bringing loan classification and provisioning requirements in line with international practice, and improving the framework for crisis preparedness. They encouraged further efforts to increase the commercial orientation of banks and to develop nonbank financial institutions, thereby promoting efficient allocation of resources. Directors welcomed plans to disengage the central bank from non-core business and to enhance its independence more broadly.

Directors noted several external constraints that are likely to hinder a return to precrisis high growth rates. It will therefore be important that Belarus pursue an ambitious structural reform strategy aimed at generating new sources of growth and improving the business climate. Privatization would play an important part in easing external financing constraints and promoting technological development. Further measures are also needed to reduce the burden of regulation and quantitative targets on the private sector. Directors encouraged the authorities to avoid recourse to additional administrative controls in response to the crisis.

Directors emphasized the importance of securing sufficient financial resources from the international community in support of Belarus’ reform efforts. They welcomed the authorities’ commitment to implement contingency measures to avoid having a financing gap.