US embassy cable - 05MINSK1145

UNCLAS MINSK 001145 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON, ETRD, BO 
SUBJECT: Trade with Russia Falls under New VAT Rules 
 
Refs: (A) Minsk 171, (B) Minsk 174, (C) Minsk 247 
 
1. Summary: In January Belarus and Russia switched the way VAT on 
bilateral trade is paid.  President Lukashenko and other GOB 
officials constantly state this change benefited Belarus, and 
bilateral trade has increased.  However, the GOB's own statistics 
show a 8.9 percent drop in commerce with Belarus' main trading 
partner.  Anecdotal evidence also points to bilateral trade being 
sharply affected.  Additionally, a leaked government memo 
highlights the damage this has done to local industry, and 
concludes this switch hurt Belarus' economy.  Meanwhile, Lukashenko 
has issued several temporary decrees to mollify Belarus' small 
entrepreneurs, who protested the VAT change last spring.  Still, 
the seeds for further protest by this group have been planted.  End 
summary. 
 
2. On January 1 Belarus and Russia switched their mechanism for 
collecting VAT on bilateral trade from the country of origin to the 
country of destination principle.  The GOB originally anticipated 
earning an additional USD 200 million in taxes annually from this 
move.  On September 19, Deputy Finance Minister Ivan Shunko 
announced the GOB may even earn an additional USD 300 million from 
VAT in 2005.  Because of the way this policy change was 
implemented, and the lack of preparation in both countries, 
bilateral trade dropped sharply in January (ref A).  GOB officials 
have repeatedly stated that VAT restructuring has not resulted in 
any problems and that trade with Russia is booming.  In February 
the Ministry of Statistics even announced that Belarusian foreign 
trade (roughly half of which is with Russia) increased 37 percent 
in January. 
 
3. However, recently released trade statistics for the first half 
of 2005, anecdotal evidence, and a leaked government memo all lead 
to the conclusion that January's restructuring of VAT has had a 
large, continuing and negative impact on Belarus' trade with 
Russia. 
 
 
The Statistics 
-------------- 
 
4. According to the MFA, trade between Belarus and Russia for the 
first half of 2005 fell by 8.9 percent, to USD 6.9 billion, 
compared to the same period in 2004.  Belarus' exports to Russia 
fell by 8.7 percent, to USD 2.656 billion, and its imports from 
Russia fell by 9.1 percent, to USD 4.289 billion.  Russia accounts 
for 36 percent of Belarus' exports and 60.5 percent of its imports. 
Belarus' main exports to Russia include tractors, trucks, metals, 
tires, household appliances, and foodstuffs.  Belarus imports from 
Russia oil, natural gas, electricity, coal, ferrous metals, 
engines, metal working machinery and chemicals. 
 
5. Despite these official statistics, GOB officials continue to 
assert everything is fine.  Prime Minister Sidorsky announced 
September 6 at the opening of the first Belarus-Russia Economic 
Forum that Belarus' trade with Russia increased by five percent in 
the first half of 2005.  President Lukashenko at the same event 
stressed at length the strength and growth of Belarusian-Russian 
trade.  However, Russian Prime Minister Fradkov replied in his 
address that he hopes bilateral trade levels for 2005 do not drop 
too far, "after many problems, such as VAT redirection."  Two 
Russian officials, First Deputy Mayor of Moscow Yury Roslyak and 
Aleksey Kaulbars, a department head at the Ministry of Economic 
Development, both stated at the forum the drop in bilateral trade 
is the result of difficulties arising from the new VAT structure. 
 
 
Everything is Good, But... 
-------------------------- 
 
6. In July Lukashenko admitted, "There was a big VAT problem early 
this year, now there is almost no problem."  He went on to claim 
that tax revenues are up by BYR 800 million [USD 372,000] for the 
year and that the new VAT scheme led many companies to increase 
their profits, some by 50 percent.  Despite Lukashenko's claims, 
several businesses have reported otherwise to Emboffs.  The owner 
of a Vitebsk brick factory said he lost all his trade to Russia 
because of the new VAT mechanism, and had to close half his 
factory.  He said this was typical in Vitebsk.  Officials at the 
Minsk Automobile Factory, Belarus' fourth largest company, admitted 
sales to Russia fell in 2005.  According to the Ministry of 
Statistics (MoS), truck sales to Russia fell 8.7 percent and the 
import of Russian cars fell 6.2 percent in the first half of 2005. 
7. According to the MoS, the new VAT scheme increased taxes paid to 
the state, up 100 percent from the year before to BYR 2.286 
trillion [USD 1.063 billion] in the first half of the year.  VAT on 
goods imported from Russia accounted for roughly 40 percent of that 
amount, BYR 457 billion [USD 213 million].  The GOB insists it lost 
an estimated USD 200 million a year to Russia under the old VAT 
scheme, and is demanding the GOR pay USD 1.2 billion in restitution 
as a precondition to any currency union. 
 
 
But Some Say it is Bad for Belarus 
---------------------------------- 
 
8. Despite the increase in tax revenue, in an internal GOB memo 
leaked to the press in August, Presidential Aide Sergey Tkachev 
argued this change was actually harmful to the Belarusian economy. 
He wrote that Russian suppliers of raw materials are not deducting 
the previous amount of Russian VAT from the cost of goods exported 
to Belarus, so Belarusian firms are paying last year's prices for 
imports (with the previous amount of Russian VAT now going to the 
Russian company) as well as an 18 percent Belarusian VAT.  In one 
example, the GOB insisted earlier in the year that Gazprom reduce 
the price of natural gas by 18 percent (from last year's rate of 
USD 46.68/thousand cubic meters) to compensate for a change in the 
VAT mechanism.  Gazprom refused, and continues to charge USD 46.68. 
Even though Beltransgaz is a state company, it still has to pay VAT 
on gas imports, effectively raising the price of gas by 18 percent 
as of January 1. 
 
9. Tkachev also argued the apparent rise in VAT revenues is a 
mirage.  When Belarusian exporters ship goods to Russia, they have 
to supply the GOB with proof VAT is paid on those goods in Russia. 
Business contacts tell Emboffs in many cases obtaining such proof 
is impossible.  When no paper work is available, the Belarusian 
exporter must pay VAT to the GOB, plus a large fine.  Even when 
paperwork is available, in many cases the Belarusian firm has to 
pay VAT to the GOB on goods it exports.  Once the company submits 
the paperwork proving VAT was paid in Russia, the GOB should 
reimburse that VAT.  Tkachev wrote that the GOB owes Belarusian 
exporters BYR 465.5 billion [USD 217 million] in overdue VAT 
reimbursement from the first half of 2005.  This accounts for 20 
percent of taxes collected during that period.  Further, he argued 
that Belarusian exporters face liquidity problems because the GOB 
has not reimbursed them for paid VAT, forcing them to seek loans to 
compensate or be delinquent in paying other bills.  Valery 
Dashkevich, an economist at BelGazpromBank, told us because the GOB 
has not been reimbursing exporters for VAT paid in Russia, most 
major Belarusian exporters have stopped paying VAT to the GOB, 
arguing their current taxes are offset by what the GOB owes.  This 
is likely to lead to sharply reduced tax revenues in the second 
half of 2005. 
 
10. Tkachev concluded, "Our revenues have shrunk, we get dearer 
Russian raw materials, the prices for which have risen - maybe not 
by the value of the VAT, but by a significant share.  We should 
also think about to whom to sell, to go through the complex method 
of confirming, returning and offsetting VAT.  It all causes a 
growing inventory of finished stock... .  The Union State has lost 
much."  Ivan Ivanov, head of the local International Finance 
Corporation office, agreed with Tkachev's assessment, "I do not 
think the new mechanism is more profitable for Belarus.  It was 
easier to trade with Russia, the main trading partner, before." 
 
 
Not all Bad 
----------- 
 
11. Even though trade with Russia fell, some analysts state the 
problems with VAT forced Belarusian companies to divert their trade 
away from Russia.  According to the MFA, trade with Ukraine rose 65 
percent in the first seven months of the year, largely based on 
increased sales of Belarusian agricultural equipment, televisions, 
refrigerators, glass, potash and oil to Ukraine.  According to the 
IMF, exports to western countries also surged.  As a result, 
Belarusian exports as a whole rose 19.6 percent, to USD 7.4 
billion. 
 
 
Entrepreneurs Satisfied, for Now 
-------------------------------- 
 
12. Belarusian entrepreneurs protested the new VAT rules in 
February and March (refs B and C).  In response, Lukashenko 
exempted individual entrepreneurs from paying the new VAT for six 
months.  On August 1 the GOB implemented a temporary rule, valid 
until December 1, allowing business owners to pay a fixed rate for 
VAT if no documents accompany the imported goods.  [Note: Thousands 
of Belarusian small businesses import small amounts of goods from 
Russia for resale, often in kiosks.  Because of the nature of this 
shuttle trade, and the customs free border with Russia, 
accompanying documents are usually impossible to obtain.]  The 
fixed rate ranges from USD 230 to 325 per month, depending on the 
type of business and its location.  Perspektiva, an NGO that works 
with small businesses and which organized the February and March 
protests, believes this VAT will force many small businesses into 
bankruptcy.  Small scale traders will have to raise their prices 10 
to 50 percent, based on their volume of sales, and will not be able 
to compete with wholesale importers who pay the same rate but deal 
in much larger volumes.  However, these moves by the GOB have 
apparently diffused the earlier anger of many entrepreneurs, which 
led to last spring's protests. 
 
 
Comment 
------- 
 
13. The GOB appeared to rush into the decision to change the way 
VAT on trade with Russia is paid, focusing solely on the perceived 
increase in taxes, and not thinking about repercussions on 
industry.  [Note: One official told Econoff the decision was only 
made in September 2004, three months before the change was 
implemented, with details worked out afterwards.]  While some 
businesses have managed to redirect their exports, others have seen 
a sharp drop in sales and had to reduce their production.  Despite 
GOB claims of constant growth and success (part of Lukashenko's 
endless propaganda that all is well in his Belarus), many appear to 
have been hurt by this move.  The entrepreneurs are quiet now, but 
that could change as businesses collapse or the GOB's temporary 
mollifying measures expire. 
 
 
KROL