1. 1 Industrial Performance: Trends in Productivity and Competitiveness CEM for Republic of Belarus

2. 2 Analysis of productivity trends and labor costs is the key to understanding the competitive position of Belarusian industry Key determinants of growth sustainability

3. 3 Strong growth in industrial productivity

4. 4 Employment and Productivity Growth,1999-2003

5. 5 Labor market flexibility Despite administrative interference in enterprises’ decisions on firing, hiring, and wage setting, there has been considerable room for labor mobility in response to market signals Labor movement generally occurred in direction from less to more productive sub- sectors Wage differentials were broadly consistent with differences in sector productivity

6. 6 Cost advantage against Russia

7. 7 Wage Growth Exceeds Productivity Improvements

8. 8 Growth in ULC Indicates Erosion in Competitiveness

9. 9 Growth in Labor Costs Drives down Profitability

10. 10 Growth Drivers Cost/wage advantage Expanding share of Russian market, gains from re-integration Wage/income growth High oil prices and strong global growth Restructuring due to competitive pressures Improved capacity utilization Eroding due to the wage policy Share of exports to Russia is too high Limits to future growth due to competitiveness concerns Cannot remain high forever The extent of restructuring is limited Insufficient investments in new capacity

11. 11 Where will new growth be coming from? …Unclear Earlier growth drivers (cost/wage advantage vs Russia, Russian post 1998 recovery, expansion in domestic demand, oil processing exports to Europe) will not be able to play the same role in the future We do not see a big new thing to push growth up Slow down in growth is quite likely

12. 12 Signs of Strain Trends in industrial productivity and competitiveness: High costs – taxes, wages, interest rates Implicit costs – price controls, social services, administrative burden Low profits Depressed investments in manufacturing

13. 13 High and distorted tax structure

14. 14 Growth is unbalanced

15. 15 Weak Investment Performance Investment structure is biased against manufacturing The bulk of industrial firms (97%): < than 4% of GDP in 1999-2003 Why? - low profitability - mostly state owned economy - excessive government interventions in credit allocation

16. 16 Capital markets remain seriously distorted Government interventions create barriers for efficient allocation of investment finance Correlation between investment growth and profitability is negative -- less profitable sectors were able to finance more investments Correlation between credit and output growth was negative as well -- credit allocation is biased toward less successful sectors Capital market is more distorted than the labor market

17. 17 Growing Competitive Pressures % of firms calling competition from import not important

18. 18 Growing concerns about competitiveness Dynamics of competitive advantage in industry (As % of the total number of respondents) QualityPrice 2002 4870 2004 56.440.1 2002 62.937.1 2004 31.441.9 Russia and CIS Outside the CIS

19. 19 Main Risks for Future Growth in Competitiveness Recent growth drivers 1. Preservation of inherited industrial base and infrastructure Risks of erosion Domestic savings are insufficient for modernization Profits are low, which limits opportunities for investments Poor investment image limits new entry, deprives the economy from benefits related to innovation and flexibility

20. 20 Main Risks for Future Growth in Competitiveness Recent growth drivers 2. Fiscal, wage and employment policies aimed at growth in domestic demand Risks of erosion Excessive labor costs growth undermines competitiveness Income policy aimed at artificially low income differentiation may facilitate emigration of entrepreneurial and educated youth Trends in the pension system are unsustainable

21. 21 Main Risks for Future Growth in Competitiveness Recent growth drivers 3. Subsidies to leading domestic exporters Risks of erosion Too much risk for both fiscal and banking systems Undermines incentives for restructuring and innovation Belarus will have to reduce its level of subsidization as art of its WTO accession process Russia may be reluctant to support the existing asymmetry in trade regimes

22. 22 Main Risks for Future Growth in Competitiveness Recent growth drivers 4. Cost and other market advantages at the Russian market Risks of erosion Costs are driven up by the wage policy, higher taxes, more expensive credit, and high costs of doing business Russian economy is too oil- dependent and thus is fundamentally risky a primary export market The economy shows a difficulty to accelerate export diversification

23. 23 Main Risks for Future Growth in Competitiveness Recent growth drivers 5. Russian energy subsidies and other transfers Risks of erosion A need to diversify energy import sources Russian domestic and export prices for gas and power are expected to grow – unavoidable costs of adjustments (up to 6% of GDP)

24. 24 Main Risks for Future Growth in Competitiveness Recent growth drivers 6. Benefits from the favorable external environment Risks of erosion Oil and other commodity prices will not remain high forever External market position of Belarus is rather fragile – it depends too much on a limited number of large exporters, which in turn depend too much on a single market If the Belarusian economy fails to accelerate restructuring, it will lose its market share in Russia and elsewhere – Ukraine is already catching up