Belarus: EFSD’S credit and reforms in the country

16 December 2016

The Eurasian Fund for Stabilisation and Development (EFSD) is Belarus’ key lender today. Belarus receives credit tranches if it complies with the terms and conditions of the credit programme promoting structural economic reforms. Why hasn’t Minsk received the third tranche yet?

Alisher Mirzoev, Director of the Project Group for Financial Credits at the EFSD, tells about credit conditions and answers some pressing questions about the economic situation in Belarus in his interview to BelaPAN.

The Council of the Eurasian Fund for Stabilisation and Development resolved to provide the second tranche of its credit to Armenia. Did the Council consider the provision of the third tranche to Belarus and when can the respective decision be made?

The Council has not considered the issue of extending the third tranche of the EFSD financial credit to Belarus yet. It may be included in the expert council’s agenda before the end of December and the Fund’s Council will meet in the beginning of the next year.

The Minister of Finance of Belarus had a meeting with Belarusian journalists on 3 October where he said he hoped the third tranche would be extended before the end of October. Why was it delayed?

The programme contains many requirements. Macroeconomic indicators are being achieved rather successfully. Structural reforms are a matter of concern, however. Structural reforms are the only measure that can ensure stable macro balances, a decrease in inflation to a level comparable with other countries that are the trade partners of Belarus, and necessary economic growth rates in the medium and long term.

In particular, the third tranche requires that the government adopt a strategy to improve management of state-owned enterprises, as well as two presidential decrees. The first will increase unemployment benefits for those dismissed as a result of the reorganisation of enterprises to the level of the minimum consumer budget, and the second will govern the transfer of continuously insolvent enterprises into trust management. The delay in discussing the third tranche of the Belarusian credit was caused by the fact that these resolutions had not been passed.

Are you satisfied with the draft of the above strategy? Will it help to improve the efficiency of the public sector in Belarus?

Overall, we are satisfied with the draft strategy we received from the government in mid-November. If it is adopted and duly fulfilled, this would be a big step forward. It will not only improve the public sector’s efficiency, but also optimise the state’s role in the economy and create favourable conditions for private sector development.

The draft strategy envisions the following: (1) separating the state’s ownership and regulatory functions; (2) introducing corporate governance and IFRS at all commercial state-owned enterprises; (3) classifying all state-owned enterprises in accordance with international principles in order to determine the list of candidates for privatisation and liquidation; (4) simplifying privatisation and bankruptcy procedures; and (5) improving the system for monitoring fiscal risks generated by state-owned enterprises, as well as the scale and effectiveness of state support.

The strategy is currently being finalised by the Belarusian side. If the approved strategy does contain the majority of measures included in the draft document and the proposed timeframes to start implementing them, we will deem this condition as fulfilled.

The framework of measures, based on which the EFSD decides whether to provide tranches to Belarus, adds the privatisation requirement in 2016. Did this happen?

We believe that privatisation should be considered as part of the comprehensive public sector reform and the above strategy aims to ensure it. As to privatisation, the current draft envisions that all state-owned entities will be classified before mid-2017 to form the list of non-strategic enterprises that can be privatised.

The timely preparation of such a list, the determination of the list of first candidates for privatisation and the actual privatisation of some enterprises may be the conditions for the disbursement of subsequent tranches of our credit. In addition, the strategy envisages significant improvements in bankruptcy procedures in line with international standards.

The simplified procedure will ensure further reform of bankrupt enterprises and their privatisation. De-jure, this means that even a strategic enterprise may go bankrupt.

As the Fund stated earlier, the framework of measures includes additional controls for the provision of the third and subsequent tranches that are aimed at improving Belarus’ debt stability. What specific changes were included in the revised framework in the second half of 2016 and why?

A significant portion of Belarus’ debt burden has formed directly or indirectly as a result of the reduced efficiency of state-owned enterprises and rather low efficiency of long-term projects financed with directed loans.

Fiscal risks are associated with the decrease in revenues and the need to provide various forms of fiscal support to state-owned entities.

This involves both direct government liabilities (the increase in the public debt to restructure or buy out bad debts of state-owned enterprises, replenish their charter capitals and recapitalise state-owned banks) and contingent liabilities (loan guarantees to central and local governments for state-owned enterprises).

The guarantees extended this year amounted to 4.5% of GDP and their accumulated volume 11.7% of GDP (in addition to a public debt of 38.6% of GDP). Over the first nine months of the year, the number of guarantees enforced by central and local governments declined to 0.6% of GDP (compared to 0.9% the year before). However, the overall risk that the government’s contingent liabilities will become direct liabilities is rather high, especially if to consider the worsened condition of enterprises because of recession.

We believe that the problem of debt stability should be solved fundamentally, by improving the performance of state-owned entities. As I said already, the strategy to improve governance at state-owned enterprises aims to solve this and we plan to support the respective measures with the current programme.

I would add, that this year a control indicator was added to the framework of measures that limits the public debt ceiling to 45% of GDP.

How would you evaluate the current policy of the National Bank, the Ministry of Finance and the Ministry of Economy? Do you agree with the actions taken by the Belarusian economic authorities?

Overall, we support the government’s macroeconomic policy. This year, the National Bank continued to pursue the policy of monetary targeting and formed money supply in accordance with its inflation target. This has helped to reduce inflation.

At present, annual inflation is within the target indicator. The National Bank has managed to cut its currency debts (and its debt burden as a result) considerably and improve international reserves by buying currency in the open market. At the same time, despite the significant volume of these purchases, the National Bank constrained the growth of money base by effectively withdrawing current liquidity.

The decline in food and raw material prices, the Ministry of Finance’s stringent fiscal policy and the significant decrease in domestic demand have also helped to slow inflation.

Despite recession and off-balance expenditure to support state-owned enterprises (payment of state guarantees, replenishment of charter capitals), the Ministry of Finance has managed to achieve budget surplus. We estimate that over the first ten months the wide surplus was 1.2-1.4% of GDP, for the first time since 2012. Expenditure may grow somewhat by the end of the year but this should not result in fiscal deficit. So, this indicator is expected to comply with the programme supported by our credit.

The National Bank and Ministry of Finance’s joint efforts to slow inflation have also helped to reduce the real effective exchange rate, which has become one of the main triggers for Belarusian exports this year.

The Belarusian government’s potential to reduce inflation further is significant: the increase in prices (although slowed) seems very high compared to inflation in the countries that are Belarus’ trade partners and the world’s average. To fulfil this potential, the National Bank and the government will need to coordinate their policies and implement decisive structural reforms.

We assess positively the efforts by the Ministry of Economy as a developer of the most important directions of structural reforms. However, we would like see more active fulfilment of these reforms. This depends, to a significant degree, on the political will of the country’s government.

One of the key concerns in 2016 is non-performing assets in the banking system that grew by more than twofold from the beginning of the year (from 6.8% to 14.9%). What are your expectations for their future dynamics and how should the Belarusian authorities react to this problem?

I would say that the current level of bad debts formed not today, but several years ago.

The reasons for this were associated to a significant extent with directed lending, which had to be re-financed with new directed loans, extended loan periods and other mechanisms. This helped to demonstrate a lower level of bad loans.

At present, the government is cutting directed loans as part of its structural economic reforms and this uncovers problems in the banking system that have formed earlier. At the same time, the more realistic indication of the level of bad debts requires an increase in provisions in order to manage risks and this constrains the possibilities for lending.

In addition to other accumulated structural imbalances, including high dollarisation, and the unfavourable foreign trade environment, the factors affecting the banking sector include recession and the worsened balance sheets of businesses, especially state-owned entities.

Directed lending will continue to be cut and the share of bad debts may grow respectively. However, the pace of this growth will be significantly lower as financial resources will be channelled into more effective projects. This will be ensured by positive effects of structural market reforms. We estimate that the share of bad loans won’t exceed 20%.

In our opinion, the transparency of the banking sector’s problems and the decisiveness of structural reforms should help not only to mobilise the respective domestic resources to manage liquidity risks, but also increase the probability for entering into a new credit programme with the IMF and other donors.

Here, too, the problem should be approached in a comprehensive manner. It is necessary to improve the effectiveness of state-owned enterprises by reforming their governance; enhance the stability of banks, restructure non-performing loans, and improve risk management associated with currency liquidity by stimulating demand for the national currency and using macro-prudential measures; as well as improve institutions responsible for managing non-performing assets (such as, for example, the Asset Management Agency established in July 2016).

These institutions should be provided with authority to buy and divide assets, replace management at enterprises, and acquire shares in enterprises in exchange for debts.

One of the conditions of the current credit programme between Belarus and the EFSD is to have a regulatory framework approved by 1 September 2016 that would protect employees who will become unemployed as a result of the reform of the public sector. At present, according to the CIS Statistics Committee, unemployment benefits in Belarus are the lowest in the post-Soviet space. Did the Belarusian side familiarise you with social protection plans in this area?

The documents aimed at extending social protection for the unemployed in connection with the public sector reform were agreed with the government in the beginning of the year.

To alleviate social consequences of cost optimisation at state-owned enterprises, including staff optimisation, it is necessary to increase unemployment benefits. As you rightly said, these are very low in Belarus at the moment (about 3% of the average salary).

Second, it is necessary to strengthen retraining mechanisms for the unemployed. These should be oriented to demand from both conventional and new sectors, including the private sector. Third, the above measures need sufficient financing.

Some of these measures have been fulfilled already. For example, amendments to the Law on Employment oblige employers to notify the Ministry of Labour and Social Protection about planned staff reductions two months in advance and envision the Ministry of Labour’s involvement in training and re-training of specialists who may be dismissed as a result of optimisation at enterprises.

The Law on the National Budget in 2017 provides for a possible increase in finance extended to the Social Protection Fund in order to compensate a part of expenditure on unemployment benefits and scholarships paid to people who pass professional development or retraining courses curated by respective governmental authorities.

As I said already, unemployment benefits have not been raised yet. According to the draft presidential decree that has been provided to us, unemployment benefits for people who will be dismissed as a result of staff optimisation at enterprises or those who get retraining courses should be increased to the minimum subsistence level.

The Belarusian authorities have recently set a task to ensure growth in salaries to US $500 in 2017 by improving labour productivity. Is this realistic and to what extent does this task correspond to the intent of the credit programme between Belarus and the EFSD?

In our opinion, this goal will be difficult to achieve if salaries increase proportionately to labour productivity. If to adhere to this principle, to raise salaries to US $500, labour productivity will need to be improved by approximately 33%, at the current exchange rate, which is two and a half times higher than the results achieved in the record 2004.

We don’t expect that labour productivity will grow with increases in output since we forecast recession to continue in 2017. The increase in productivity due to staff optimisation at state-owned enterprises is possible and advisable. However, we don’t expect this optimisation will be large-scale.

At the same time, we estimate that labour productivity in the private sector may be significantly higher than at state-owned enterprises. For example, in the private dairy sector it was 50% higher in 2014 than at state-owned entities, which suggests that excessive employment at state-owned enterprises amounts to 23%.

I think there should be no hopes on the improvement of the nominal exchange rate as one of the theoretical ways to achieve this goal because it will have too many negative consequences for the economy and there are no fundamental reasons for this.

The EFSD and the Belarusian sides have continuous consultations. Did the Fund’s experts submit any additional recommendations for the Belarusian government in respect of its macroeconomic policy?

Our most recent discussions with the government were about the speed of the decrease in the refinancing rate. We recommended that the National Bank should abstain from decreasing the rate while the current account deficit continues to expand, the devaluation and inflation expectations are high, and the exchange rate of the Belarusian rouble is overly appreciated (we estimate it to be above the actual rate by 7-12%).

We agree with the government that the increase in the current account balance is connected to the energy balance, in particular because of the worsened conditions of trade in oil and oil products. However, we have very different approaches to it: the government sees it as an environmental factor and we as a structural, fundamental one.

In the medium term, the price of oil would hardly exceed US $60 (our estimate is within the range of US $50-60). This necessitates quicker structural reforms to ensure a fuller use of the export potential.

At the same time, we acknowledge that rate reductions do not result in an unbalanced increase in liquidity (this would threaten the possibility to achieve monetary thresholds envisioned by the EFSD framework of reforms, as well as the inflation targets). Therefore, we would admit a certain reduction in rates with inflation slowdown.

Another important topic for discussion is the reduction in administrative pricing. The Belarusian government continues to control directly the most significant portion of the consumer price index basket as compared to other EFSD countries (22% vs. 14-12% in other countries).

It is planned that control will be cut to 20% only by the end of 2017. In the future, price regulations in the EAEU countries are expected to be harmonised. However, Belarus may remain a "leader" in terms of state interventions after that as well, because harmonisation provides a room for manoeuvre.

We also talk a lot about excessive employment at state-owned enterprises. This remains one of the key obstacles to improving the structural flexibility of the economy and its systemic reform.

Excessive employment may be the most important reason behind the ineffective performance of some state-owned enterprises. The negative effect of this phenomenon on the economy is apparent. Excessive employment concentrates labour and, consequently, financial resources at non-performing enterprises and prevents them from flowing into more productive and promising sectors.