Republic of Lithuania and the IMF

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Lithuania—Letter of Intent,
Supplementary Memorandum of Economic Policies,
and Technical Memorandum of Understanding

Vilnius, December 20, 2001

The following item is a Letter of Intent of the government of Lithuania, which describes the policies that Lithuania intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Lithuania, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431

Dear Mr. Köhler:

1. The overarching objective of Lithuania's economic policies is to promote sustained economic growth and improved living standards through continued macroeconomic stability and further implementation of structural reforms necessary for an efficiently functioning of market economy and enhancement of competitiveness. Early accession to the EU and NATO is our main policy goal. The key elements of our economic policy strategy will be to maintain the currency board arrangement as the cornerstone of macroeconomic stability; to further fiscal consolidation in order to support external viability; and to advance the remaining key structural reforms at a fast pace. The attached Supplemental Memorandum of Economic Policies (SMEP) lays out the concrete policy measures to be taken during December 2001 and 2002.

2. In support of the policies detailed in the SMEP, we request approval of the first review of the stand-by arrangement with the International Monetary Fund (IMF) that was approved by the IMF Executive Board on August 30, 2001 in an amount equivalent to SDR 86.52 million. We do not envisage at this time making purchases under the arrangement, but could do so if economic circumstances were to be worse than expected. We understand that the Fund will continue to monitor the program on the basis of quarterly performance criteria, and two more program reviews will be conducted, as described in the original Memorandum of Economic Policies signed on July 26, 2001 and the SMEP. As a demonstration of our commitment, Seimas passed on December 13, 2001 the budget for 2002, comprising the national budget and the budgets of the Social Insurance, Health Insurance and Privatization funds, in line with paragraph 29 of the SMEP.

3. We believe that the policies described in the SMEP are adequate to achieve the objectives of the program, but will stand ready to take additional measures as necessary to achieve those objectives. During the period of the arrangement we will consult with the IMF on the adoption of any such measures that may be appropriate, in line with the Fund's policies on such consultations.

4. We are committed to transparency in our economic policies, and we authorize the Fund to publish this letter and the SMEP following Executive Board consideration of the first program review and 2001 Article IV consultation discussions.

Yours sincerely,

Algirdas Brazauskas
Prime Minister
Reinoldijus Sarkinas
Chairman of the Board
Bank of Lithuania

Republic of Lithuania

Supplementary Memorandum of Economic Policies of the Government and the Bank of Lithuania for the Period December 2001-02

I. Introduction

1. The economic program supported by the Stand-by Arrangement (SBA) with the IMF is being implemented with positive results. In 2001, growth accelerated, the external position of the economy strengthened, spreads on government securities fell to their historic lows, and structural reforms generally advanced. Confidence in Lithuania's policy-making remains strong in the run-up to the repegging. The economic program is on track and the main objectives of the program described in the Memorandum of Economic Policies (MEP) of July 26, 2001 remain valid. However, certain adjustments to program targets and the timing of some measures are needed in response to changing circumstances and to address weaknesses which program implementation has made apparent.

2. The macroeconomic situation continued to improve in the first nine months of 2001, with a gradual recovery in domestic demand now complementing export-led growth. Real GDP growth (year-on-year) amounted to 5.1 percent for the first half of the year and, according to preliminary estimates, output continued to grow at around this rate in the third quarter. After having fallen by nearly 10 percent last year, investment increased by 8.3 percent (year-on-year) in the first half of 2001. Inflation remained relatively subdued, consistent with wage moderation and with the lagged effects of the earlier appreciation of the litas against the euro. The unemployment rate has declined by around 1 percentage point since its April 2001 peak, but remained at 12.2 percent in October.

3. All program performance criteria and structural benchmarks for end-September were met, despite revenue shortfalls. However, the problem of expenditure arrears persisted in the state budget and the Health Insurance Fund, resulting in the non-observance of the indicative target on central government expenditure arrears. Further progress was made in the fiscal structural area. The draft law on the Methodology of Revenue Redistribution among Municipalities was passed by Seimas on October 23, 2001, and the pricing and definitions of state-mandated obligations were included in the draft 2002 budget law. Moreover, preparation for extending the real estate tax to residential property in 2003 is ongoing. Finally, Seimas has approved an amendment to the Privatization Law, authorizing the establishment of a Reserve Stabilization Fund (RSF). The government established the RSF by a resolution approved on December 18, 2001 and will, by March 2002, submit regulations on RSF operations to Seimas for approval.

4. Other structural reforms continued to advance. The government has announced its plan for the privatization of the Lithuanian Gas Company (LG), under which a 34 percent stake will be offered to a strategic foreign investor, followed by another 34 percent stake to a gas supplier. A tender for the privatization was announced in November 2001. The Lithuanian Power Company (LPC) is being restructured into 5 new utilities covering power generation, distribution, and transmission, with a view to eventual privatization. The distribution of authorized capital and liabilities among the new successor companies has been approved by Seimas. The privatization of the banking sector is nearing completion following the submission of a bid for the purchase of the Lithuanian Agricultural Bank (LZUB). An advisor for the restructuring and privatization of Lithuanian Airlines (LA) was selected at end-October. Recent measures requiring company shareholders with controlling stakes to make a buy-out offer to minority shareholders, and allowing sales at market value rather than book value, have helped to accelerate the sale of small residual state shareholdings and land plots, raising an average of some LTL 50 million per month through 2001. In agriculture, a revised draft constitutional amendment to allow agricultural land sales to foreigners, in compliance with EU requirements, is expected to be passed by Seimas shortly. Legislation to introduce national accounting standards that are compatible with EU regulations, and a new labor code governing the relationship between employees and employers, have been submitted to Seimas. Significant progress has been made on accession negotiations with the EU. The government has completed 18 of 31 chapters so far, and aims to close a further 3-4 by year-end, and the remaining chapters in 2002, paving the way for Lithuania's accession to the EU in 2004.

5. Regarding program implementation, good progress has been made so far. In addition, the government is committed to intensifying its efforts in a number of areas. The government sees an urgent need to speed up the reform of the tax system, to finalize the set of reform measures of municipal finances, to restructure the operations of the Health Insurance Fund, and to continue its efforts to improve the business environment and reduce unemployment.

II. The government's program

A. Macroeconomic outlook

6. The macroeconomic outlook for 2001-02 envisages continued growth, low inflation, and the maintenance of the external current account deficit at a sustainable level. Real GDP is expected to grow by 4.5 percent in 2001 and 4.0 percent in 2002. A gradual recovery of both private consumption and investment is projected to be the main contributor to growth in the second half of 2001 and the first half of 2002, as the ongoing slowdown in the EU and other trading partners is likely to have a negative impact on export performance. The recovery in domestic demand will be supported by the recent decline in interest rates which is expected to lead to an acceleration of credit growth to the private sector. The external current account deficit is projected to reach 5.8 percent in 2001--a deterioration relative to the first half of 2001, but better than originally expected--and to remain broadly unchanged in 2002, as lower growth of non-energy exports to the EU would be offset by the strength of exports to CIS markets and a reduced import bill due to a projected further decline in oil prices. The reduction in the current account deficit would be supported by the continuation of fiscal restraint in 2002. The current account deficit would be financed by strong capital inflows, including a pick-up in foreign direct investment.

7. Average inflation is projected to remain subdued at 1.4 and 2.8 percent in 2001 and 2002, respectively. Continued growth is expected to facilitate a further gradual decline in unemployment and a resumption of modest growth in real wages, over the second half of 2001 and through 2002.

B. The currency board arrangement

8. The currency board arrangement continues to be the main anchor of economic policies. The repegging of the litas from the U.S. dollar to the euro will take place on February 2, 2002 at 4.0000 times the reference exchange rate of the U.S. dollar vis-à-vis the euro announced by the European Central Bank on February 1, 2002. New guidelines for the management of gross official reserves consistent with the new reserve currency have been adopted, timely provisions of euro coins and banknotes have been ensured, and technical aspects of the interbank and foreign exchange markets on the day of the repegging have been fine-tuned. The BoL is intensifying the public information campaign on the repegging. The BoL and the government are confident that they have taken all necessary steps to ensure that economic agents are prepared for the repegging.

9. The strong balance of payments position and sustained confidence in the banking system would lead to a further monetization of the economy. Broad money is expected to grow by 15 percent in 2002. Credit growth would accelerate to 16 percent, as recent privatizations in the banking sector lead to greater competition and interest rates decline further, reflecting strong confidence and low interest rates in the euro area. Further reduction of the required reserve ratio is envisaged for 2002, with the timing announced early in the year in consultation with IMF staff.

C. Fiscal policy and fiscal structural reforms

10. Under the CBA, fiscal policy is the major instrument of macroeconomic management. The achievement of a credible budget deficit reduction path through the maintenance of fiscal consolidation continues to be at the core of the authorities' strategy. Continued fiscal adjustment will underpin the credibility of the CBA and lead to further reductions in borrowing costs for the public and the private sectors. To help ensure long-term fiscal sustainability, the government is committed to achieving a structurally balanced budget in the medium term (excluding the cost of the pension reform).

11. Stabilizing the revenue-to-GDP ratio has become a government priority in order to ensure medium-term fiscal sustainability. The continued decline in the revenue-to-GDP ratio in 2000-01 is in part attributable to the changing structure of GDP and in part to wider use of loopholes and inconsistencies in existing tax legislation. The government has decided to tackle this problem by overhauling the entire tax system instead of amending current tax legislation. The need to put in place a more comprehensive, internally consistent and stable tax system requires careful technical consideration and political consensus. This will take time to achieve and thus the reforms will mostly be implemented from 2003. A new law on excises consistent with EU requirements has already been passed by Seimas, and new laws on value added tax (VAT) and corporate income tax (CIT) were submitted to Seimas in December. A new personal income tax (PIT) law will be submitted to Seimas by end-January 2002. The new legislation will remove exemptions and broaden tax bases in accordance with EU requirements and taking into consideration the recommendations of the June 2001 mission of the IMF Fiscal Affairs Department. Specifically, the tax reform is intended to be revenue neutral. The new VAT law will eliminate exemptions in stages, starting with the service sector in 2002, by the time of EU accession, and the new CIT law will eliminate exemptions for reinvested earnings and lower the tax rate. To the extent that the revised CIT law raises additional revenues, the PIT rate would be further reduced while ensuring it is consistent with the medium-term fiscal objectives. Subject to Seimas' approval, the law on the CIT would become effective in January 2002, the law on the VAT would become effective in July 2002, and the law on PIT in January 2003. In addition, the government intends to extend the coverage of the real estate tax to residential property from January 2003.

12. On the expenditure side, there are a number of priorities and obligations to which the government is committed: the costs of EU and NATO accession, the closure of the Ignalina nuclear power station, environmental remediation, pension reform, improvements to social expenditure, and the clearance of remaining expenditure arrears. The savings and land restitution programs represent additional substantial obligations that could only be fulfilled over a long period of time, given other pressing expenditure needs. The public investment program will be geared towards infrastructure, environmental and other projects necessary for EU accession, and towards further improvements in health and education.

13. For 2001, a revenue shortfall of the general government estimated at 0.8 percent of GDP would be largely offset by lower-than-estimated expenditure in some areas and expenditure cuts. Fiscal performance remains in line with program commitments (MEP paragraph 12), and the government will strive to attain its 1.4 percent of GDP deficit target. However, in view of heightened uncertainty and possible further revenue shortfalls, for added flexibility, the program ceiling has been revised to 1.7 percent of GDP, which is still consistent with the attainment of macroeconomic objectives. To limit revenue shortfalls, VAT administration has been strengthened, especially by the customs department. Lower state budget expenditure on interest and savings on provisioning for defaults on guaranteed debt, together with lower than estimated expenditure of the Social Insurance Fund (SoDra) and other expenditure cuts of the state budget will ensure the achievement of the deficit target.

14. For 2002, a draft budget with a general government deficit of 1.5 percent of GDP was submitted to Seimas. The initial program deficit target was increased by 0.2 percent for a number of reasons. First, the revenue-to-GDP ratio is declining due to the erosion of the base of the corporate, personal, and value added taxes under the current legislation. Second, given the expenditure obligations related to NATO and EU accession, there is not much room for further expenditure cuts, in particular in investment spending. Third, despite the global economic slowdown, Lithuania's macroeconomic conditions are favorable and external current account prospects are better than originally expected, reducing external vulnerability risks. Finally, the increase in the budget deficit would be consistent with the credibility of the CBA, while additional financing could be readily mobilized.

15. A number of tax measures will be implemented in 2002 to limit the decline in the revenue-to-GDP ratio before the main elements of the tax reform package become effective from 2003. These measures include: (i) higher excises on diesel fuel, other fuels such as liquid gas and gasoline, and cigarettes; (ii) conversion of some EU-incompatible excise taxes into specific taxes; (iii) the elimination of some VAT exemptions and introduction of restrictions for VAT deductions on passenger cars; (iv) the extension of full pension insurance to certain groups of self-employed; and (v) improvements in tax administration targeting VAT collections and customs. At the same time, the tax exempt minimum of the PIT will be increased from LTL 214 to LTL 250 from April 1, 2002.

16. Expenditure would decline by 0.4 percent of GDP, but it would grow in real terms. Consolidated expenditure of the national budget and the road program will be cut by 0.3 percent of GDP, while ensuring that priority social spending and investment needed for EU and NATO accession are adequately provided for. Further, measures to limit expenditure of the HIF on pharmaceuticals will yield additional savings (paragraph 20). The expenditure of SoDra would decline relative to GDP, given the current indexation procedure. Nominal expenditure on investment projects by the Privatization Fund will remain unchanged compared with 2001. Finally, expenditure for savings and land restitution will be limited to 0.1 percent of GDP.

17. The current global slowdown would adversely affect Lithuania's growth prospects. In the event of a larger than expected slowdown, the government will, in the first instance, let the automatic stabilizers operate to support economic activity. In the event of a severe or protracted slowdown, however, resulting in a substantial loss of revenue, or sharp increase in the cost of financing, the government will take, in consultation with IMF staff, appropriate revenue and expenditure measures necessary to ensure fiscal sustainability. The cautious fiscal stance planned for 2002 would place Lithuania in a strong position to cope with the adverse impacts of potentially more difficult external economic developments.

18. In 2002, the financing strategy of the government will be geared toward diversifying and lengthening maturities of treasury securities, and tapping the eurobond market. Gross financing needs of the government of around 7 percent of GDP would be almost equally split between domestic and foreign sources. Should access to international financial markets become less favorable due to global emerging market conditions, a combination of the use of liquid resources of the government and a slightly higher issuance of domestic securities would allow for covering financing needs in 2002. The medium-term sustainability of public debt is expected to improve in 2002, as public and publicly guaranteed debt is expected to decline from 28.9 percent of GDP in 2001 to 28.4 percent in 2002. In light of possible defaults on direct and guaranteed loans to domestic enterprises, the government is committed to strengthening its collection efforts, further limiting the concession of such guarantees and tightening the conditions for eligibility.

19. Having clearly defined the expenditure functions of municipalities, the efforts to strengthen their finances will focus on enhancing expenditure management and finding new sources of revenue. These measures would address the structural causes of municipal expenditure arrears, thereby helping to clear the outstanding stock. Based on the new legislation, which defines methodologies for establishing costs of service provision, about 55 percent of municipal revenues will be earmarked to finance the functions delegated by the state and the student's basket. Regardless of revenue performance, the amount of earmarked transfers for the above two purposes is guaranteed. By contrast, in the event of a shortfall in PIT revenue and other taxes commissioned to municipalities earmarked for financing other municipal functions, municipalities will be required to take revenue and/or expenditure measures in other areas to maintain strict financial balance. Legislation giving municipalities more discretion in setting tax rates and fees accruing to local budgets--including a real estate tax of up to 1.5 percent of assessed property values will be submitted to Seimas by end-January 2002. This would lead to greater predictability in revenue and flexibility in the financial management of municipalities. In line with its commitment not to undertake any unconditional bail-outs, the central government will assist municipalities in reducing the stock of expenditure arrears by allocating LTL 200 million worth of additional transfers over the next three years, of which LTL 64 million would be made available in 2002 in equal quarterly installments. The municipalities will submit schedules for the corresponding reduction of arrears, and disbursements will be linked to their fulfillment. Compliance with the quarterly schedules by the municipalities will be a structural benchmark as of the second half of 2002. To further strengthen financial control, the Cabinet-level commission on expenditure arrears will continue its monthly monitoring of the clearance of municipal arrears and the State Control will conduct audits of another 30 municipalities in 2002, with penalties for municipalities found not to be in observance of the new legislation. Moreover, in order to enhance transparency the authorities will continue to publish quarterly municipal financial statements. As a general principle, the general government will strictly refrain from recourse to mutual debt cancellation or other netting or offset schemes, including with suppliers and tax payers. Finally, as part of the municipal finance reform, municipal borrowing limits have been lowered to correspond to municipalities' own resources. Moreover, in view of the weaknesses of municipal finances, the central government will not support external borrowing by municipalities aside from projects covered by the state public investment program and/or borrowing from international financial organizations.

20. The government has undertaken a number of significant steps to eliminate the arrears of the HIF and substantially improve its medium-term financial position. The government approved a decision on the rescheduling of the arrears on pharmaceuticals on December 18, 2001 and will start negotiations on its terms. These steps would effectively lead to the elimination of the stock of pharmaceutical arrears. In order to strengthen the HIF's financial situation, the current system of reimbursements for pharmaceuticals will be changed on January 1, 2002. First, the list of pharmaceuticals subject to reimbursement will be reduced by 130 items. Second, cases in which pharmaceuticals are subject to 100 percent reimbursement will be substantially reduced. Third, tighter regulation of prescription of the most expensive pharmaceuticals will be adopted. Fourth, financial incentives for controlling pharmaceutical costs by physicians will be introduced. These measures will help save about LTL 100 million already in 2002. The government will also submit amendments to the law on Mandatory Health Insurance by January 2002 establishing more effective reimbursement procedures.

21. The government will submit to Seimas a revised Concept of the Pension Reform by end-December 2001. The main principles of the pension reform outlined in the MEP (paragraph 17) remain unchanged. The cost of the pension reform is currently estimated at 0.6 percent of GDP per year, at the initial stage of the reform, given the decision of the government to reduce the maximum mandatory age for the participation in the pension reform to 30 years. The government plans to finance the transition cost of the pension reform, partly by privatization proceeds. The new system would be in place from 2004 when SoDra is expected to start generating surpluses (before the remittance of 5 percentage points of the payroll tax to the second pillar) and when the State Tax Inspectorate will have gained sufficient operational experience after merging with the payroll tax collection unit of SoDra. To this end, the government has submitted to Seimas amendments to the laws on Social Security and on Tax Administration necessary to complete the merger. In addition, legislative acts necessary to limit expenditure on state pensions through tighter eligibility requirements and revised calculations of benefits will be submitted to Seimas in the course of 2002. Finally, Seimas approved on November 20, 2001 amendments to the law on Social Security to extend the requirement of mandatory full pension insurance to certain groups of self-employed. This measure will yield LTL 20 million in additional revenue in 2002. Other legislative acts pertaining to the pension reform (MEP, paragraph 17) will be submitted to Seimas following the passage of the pension reform concept in 2002.

22. The government intends to request from the IMF a Report on the Observance of Standards and Codes (ROSC) on fiscal transparency for 2002. The report will assess fiscal transparency practices in Lithuania following the requirements of the IMF Code of Good Practices on Fiscal Transparency--Declaration of Principles. The government will review the current practices in the areas identified as needing improvement by the report.

D. Other structural policies

23. Financial sector reforms will draw on recommendations from the reports and assessments of the joint missions of the World Bank-IMF Financial Sector Assessment Program (FSAP). Reforms will aim to further enhance the resilience of the financial system and to foster a broadening and deepening of the range of financial products and services available. Specific areas of attention in the banking system will include enhancing the use of risk assessment and management techniques, improving disclosure by banks, enhancing the quality of borrower financial statements, including via adoption of national accounting standards (MEP paragraph 20), and continuing cross-border supervisory cooperation. In housing finance, policies will aim to better target public support and to focus on the development of instruments, rather than new institutions. In leasing, consideration will be given to regulatory and tax changes to remove conditions that presently discourage leasing vis-à-vis bank finance. Finally, in insurance, efforts will target improvements of corporate governance and market oversight, including by strengthening the independence and capacity of the insurance supervisory agency.

24. The government believes that improvements to the business environment remain the key to enhancing the climate for investment, attracting foreign direct investment, and strengthening competitiveness. The government is putting in place measures to streamline company registration and liquidation procedures, including through the establishment of a new company registry by January 2002. The government will also use support available through the EU PHARE program to: (i) ensure the effective implementation of new insolvency laws adopted in July 2001, through the provision of formal training for administrators and judges on new bankruptcy procedures, and preparation of a manual on bankruptcy and restructuring procedures; and (ii) assess the competitiveness of Lithuanian businesses. In addition, the government will continue to follow the recommendations of the sunrise commission regarding the streamlining of business regulation.

25. The government remains committed to further reducing unemployment, through enhanced labor market flexibility and the provision of well-targeted training opportunities, while at the same time protecting the most vulnerable sections of society. The government is continuing to provide job training programs that are targeted towards the projected future employment needs of the private sector. The new labor code is expected to introduce flexibility in the setting of the minimum wage, with provisions for lower minimum wages for specific groups, certain classes of unskilled workers and possibly certain regions. With passage of the new labor code, expected in the first half of 2002, laws on Works' Councils and on Lockouts will be proposed to Seimas in the second half of 2002. The Unemployment Insurance Law, which strengthens the insurance element in the payment of unemployment assistance, will be submitted to Seimas by end-June 2002. In addition, the government is committed to maintaining social cohesion by ensuring that the social safety net provides the necessary support to the most vulnerable groups, and will seek to improve the targeting of social assistance programs in this regard. The law on Social Assistance in Cash, which will be submitted to Seimas by end-June 2002, will change eligibility norms and replace the current general reduction in housing bills with cash payments targeted to the long-term unemployed.

26. The development of an efficient and competitive energy sector remains a key policy objective, and the government is proceeding with plans to restructure and privatize the Lithuanian Power Company (LPC) and Lithuanian Gas (LG). Registration of the restructured LPC successor companies--a precursor to privatization--is expected to be completed by the beginning of 2002 together with the settlement of a remaining US$45 million of outstanding claims on Belarus for electricity deliveries through the sale of debt to third parties. It is expected that the successor companies will be offered for sale in the second half of 2002. The staged privatization of LG will take place in 2002, with the initial sale of a 34 percent stake to a strategic foreign investor likely to be completed by May 2002, followed by the sale of the second 34 percent stake to a gas supplier in the second half of the year. The government will limit its further financial involvement in Mazeikiu Nafta's investment plan and operations to the US$118 million in guarantees already committed.

27. More generally, the privatization program, which has been a key part of efforts to increase efficiency and promote the overall restructuring of the economy, is nearing completion. Lithuanian Airlines is expected to be restructured and ready for privatization by April 2002. The cargo business of Lithuanian Shipping Company (LISCO, the rest of which was privatized in early 2001) will be offered for sale in the second half of 2002. The government is also committed to the privatization of Lithuanian Railways (LRR), following a comprehensive reorganization of the company over the next two years along the lines approved by the government in May 2001. The government plans to continue with the rapid sale of over 3,000 small residual state shareholdings and land plots, and the State Property Fund is preparing an inventory of such assets to facilitate this process.

28. The government remains committed to rationalizing its support for the agricultural sector, with a view to EU accession. The government will draw on the expertise of the World Bank in aiming to reduce the losses of the Agricultural and Food Products Market Regulation Agency (AFMRA) stemming from market support, procurement, and storage operations, including through the adoption of legislation in the first half of 2002 that would terminate the government's authority to regulate the prices of primary and processed agricultural products. The government will continue to foster rural development and investments in rural infrastructure through its efforts to facilitate the implementation of EU SAPARD programs, and through its own development program.

III. Program monitoring

29. Passage of the budget for 2002 by Seimas, comprising the national budget, and the budgets of SoDra, the HIF, and the Privatization Fund, consistent with program commitments, will constitute a prior action for the completion of the first review. The program is monitored on the basis of quarterly quantitative performance criteria and benchmarks and a set of structural policy benchmarks for end-December 2001, end-March 2002, and end-June 2002 consistent with the revised economic program (specified in the attached tables), and the second review by the IMF Executive Board. The definitions of program targets are provided in the Technical Memorandum of Understanding (Annex).

30. The second review will be based on end-March 2002 outcomes and is expected to be completed by end-June 2002. The review will focus on the design of a set of measures following the recommendations of the FSAP and ROSC missions, and further progress in tax reforms and municipal finances.

Table 1. Lithuania: Performance Criteria for Stand-By Arrangement, 2001-20021
           Target  Adjusted Target    Outcome2    

Continuous performance criteria            
  I.   Exchange rate            
      LTL 4 per US$13   . . . . . . Observed through end-September
  II.   100-percent coverage of currency board liabilities, in percent   100 . . . Observed through end-September
  III.   Reserve requirements, in percent4       6 . . . Observed through end-September
  IV.   Non-accumulation of new external payments arrears   . . . . . . Observed through end-September
Quantitative performance criteria              
  I.   Ceiling on the general government deficit, mln. LTL              
    Cumulative from January 1, 2001              
      March 31, 2001
    (previous arrangement)
  271   287     94  
      June 30, 2001   460   496   322  
      September 30, 2001   600   704   444  
      December 31, 2001   841   . . .   . . .  
    Cumulative from January 1, 2002              
      March 31, 2002   383   . . .   . . .  
      June 30, 2002   576   . . .   . . .  
      December 31, 2002   776   . . .   . . .  
  II. Floors on net foreign exchange coverage of the currency board arrangement, mln. US$              
      March 31, 2001
   (previous arrangement)
  -127   . . .    -39  
      June 30, 2001   -127   . . .    -24  
      September 30, 2001   -127   . . .      -2  
      December 31, 2001   -127   . . .   . . .  
      March 31, 2002   -127   . . .   . . .  
      June 30, 2002   -127   . . .   . . .  
      December 31, 2002   -127   . . .   . . .  
         All maturities 1-5 year   maturity All maturities   1-5 year  maturity  

          (medium- and long-term)
  III.   Ceilings on contracted public
and publicly guaranteed medium- and long-term external debt; mln. US$
    Cumulative from January 1, 2001              
      March 31, 2001
   (previous arrangement)
 293  200 183  0  
      June 30, 2001  433  200 194  0  
      September 30, 2001  648  200 194  0  
      December 31, 2001  683  200 . . .  . . .  
    Cumulative from January 1, 2002              
      March 31, 2002  450  200 . . .  . . .  
      June 30, 2002  610  200 . . .  . . .  
      December 31, 2002  640  200 . . . . . .  
  IV.   Ceilings on the outstanding
stock of public and publicly
guaranteed short-term
external debt; mln. US$
    Maximum stock during the period              
      March 31, 2001
   (previous arrangement)
  0   . . .   0  
      June 30, 2001   50   . . .   0  
      September 30, 2001   50   . . .   0  
      December 31, 2001   50   . . .   . . .  
      March 31, 2002   200   . . .   . . .  
      June 30, 2002   200   . . .   . . .  
      December 31, 2002   200   . . .   . . .  

Source: Lithuanian authorities; and Fund staff estimates.
1Definitions and exclusions are presented in the Technical Memorandum of Understanding. Numbers for end-June 2001 are indicative targets, numbers for end-September 2001, end-December 2001, end-March 2002, and end-June 2002 are performance criteria, and numbers for end-December 2002 are indicative targets.
2Based on latest available data.
3This performance criterion will be modified on February 2, 2002 consistent with SMEP paragraph 8.
4This is consistent with the required reserve ratio of 8 percent.

Table 2. Lithuania: Quantitative Benchmarks for Stand-By Arrangement, 2001-2002
      Ceiling Outcome

I.   Domestic guarantees, mln. LTL    
  Outstanding stock    
    March 31, 2001 (previous arrangement) 319 217
    September 30, 2001 314 232
    December 31, 2001 312 . . .
    March 31, 2002 315 . . .
    June 30, 2002 312 . . .
    December 31, 2002 312 . . .
II.   Central government arrears, mln. LTL    
  Outstanding stock    
    March 31, 2001 (previous arrangement) 0 19
    September 30, 2001 0 37
    December 31, 20011 0 . . .
    March 31, 2002 0 . . .
    June 30, 2002 0 . . .
    December 31, 2002 0 . . .

Source: Ministry of Finance; and Fund staff estimates.
1A government decision to clear pharmaceutical arrears will be considered as clearance of arrears

Table 3. Lithuania: Structural Benchmarks for Stand-By Arrangement, 2001-2002
Measure Date Status

Submit to Seimas draft amendments to the Law
on Revenue Redistribution of Municipalities
end-September 2001 Done
Submit to Seimas draft amendments to the
Privatization Law for establishing the Reserve Stabilization Fund
end-September 2001 Done
Tender for privatizing the Agricultural Bank end-September 2001 Done
Government's decision on a set of measures to overhaul municipal finances end-December 2001 Done
Submit to Seimas draft amendments to the Law
on Social Security needed for the pension reform
end-December 2001 Replaced with another
Submit to Seimas legal amendments on
accounting standards
end-December 2001 Done
Submit to Seimas a new labor code end-December 2001 Done
Submit to Seimas a Pension Reform Concept end-December 2001  
Submit to Seimas draft CIT and VAT end-December 2001 Done
Submit to Seimas draft PIT law end-January 2002  
Submit to Seimas amendments to the law on Tax Administration and law on Social Security on the merger of the SoDra's payroll tax collection unit
with STI
end-January 2002 Done
Finalize quarterly plan for arrears reduction of municipalities end-March 2002  
Submit to Seimas the draft unemployment
insurance law
end-June 2002  

Source: Lithuanian authorities.


Technical Memorandum of Understanding
For the 2001/2002 Stand-By Arrangement

1. This Memorandum defines variables that constitute quantitative performance criteria and benchmarks for the stand-by arrangement and sets out the reporting requirements for the government and the Bank of Lithuania.

I. Performance Criteria on the Operation of the Currency Board Arrangement

Maintenance of exchange rate under currency arrangement

2. The present exchange rate of LTL 4 per $1 will be maintained throughout the period of the program. The currency of the peg will be changed at the time of the repegging. In this connection, all performance criteria related to the currency board arrangement will be adjusted accordingly at the time of the repegging.

Cover for currency board arrangement

3. The Bank of Lithuania will ensure the maintenance of not less than 100 percent foreign reserve backing for the Bank of Lithuania's liabilities, as defined in paragraph 4 below under the currency board arrangement for the duration of the stand-by arrangement.

4. Foreign reserves backing will consist of the gross foreign reserves of the Bank of Lithuania, as defined in paragraph 10, expressed in Litai at the official exchange rates of the Bank of Lithuania. The Bank of Lithuania's Litai liabilities under the currency board arrangement comprise:

    (i) Litas notes and coins in circulation

    (ii) correspondent accounts of and certificates of deposit and other Litas liabilities to commercial banks and nonbank financial institutions;

    (iii) government deposits;

    (iv) staff and other private sector deposits;

    (v) correspondent accounts of foreign central banks.

Required reserves of the banking system

5. Average reserve deposits of the banking system over each required reserve holding period established by the Bank of Lithuania (running from the 13th of one month to the 12th of the next month) shall not be permitted to be below required reserve deposits of the banking system, as defined in paragraph 6, by more than 2 percentage points of eligible liabilities, as defined in paragraph 6.

6. All banks will be required to hold reserve deposits on account with the Bank of Lithuania of not less than 8 percent of their domestic and foreign currency deposit liabilities. Together, these shall constitute the required reserve deposits of the banking system. The deposit aggregates against which required reserves of the banking system shall be calculated will be referred to as "eligible liabilities," as defined in the 28. December 1993 Resolution No. 52 of the Board of the Bank of Lithuania ("On Confirmation of the Rules for Required Reserves for Commercial Banks"). Average reserve deposits of the banking system for each reserve maintenance period will be calculated at the end of each holding period as a percentage of eligible commercial bank liabilities.

7. The Bank of Lithuania will extend new credits to banks only and in amounts that do not violate (i) the performance criterion requiring full foreign currency backing for currency board liabilities or (ii) the performance criterion specifying the minimum targets for net international reserves.

Performance criterion on floor on net foreign exchange coverage of the currency board arrangement

8. International reserve assets and liabilities shall be valued in U.S. dollars using the Bank of Lithuania's official rates prevailing at each test date. For the period of the program, monetary gold will be valued at market prices according to BoL internal guidelines.

9. Net foreign exchange coverage of the currency board arrangement is defined as:

    (i) gross foreign reserves of the Bank of Lithuania, less foreign reserve liabilities;


    (i) foreign currency-denominated liabilities of the Bank of Lithuania to domestic residents and privatization proceeds of the government held in the Bank of ithuania; and

    (ii) Litai liabilities of the Bank of Lithuania, as defined in paragraph 4, under the currency board arrangement, less deposits withdrawn through deposit auctions and any central bank bills.1

10. Gross foreign reserves of the Bank of Lithuania shall be defined as:

    (i) monetary gold holdings;

    (ii) holdings of SDRs;

    (iii) reserve position in the IMF; and

    (iv) holdings of foreign exchange in convertible currencies by the Bank of Lithuania.

11. Excluded from gross foreign reserves are:

    (i) capital subscriptions to foreign financial institutions;

    (ii) long-term nonfinancial assets of the Bank of Lithuania;

    (iii) convertible currency-denominated claims on domestic banks;

    (iv) assets in nonconvertible currencies; and

    (v) foreign assets pledged as collateral or otherwise encumbered.

12. Fund staff will be informed of details of any gold sales, purchases, or swap and derivative operations during the program period, and any resulting changes in the level of gross foreign reserves that arise from revaluation of gold carried out according to the accounting practice of the Bank of Lithuania will be excluded from gross reserves as measured herein.

13. Foreign currency-denominated reserve liabilities of the Bank of Lithuania shall be defined as:

    (i) the Bank of Lithuania's convertible foreign currency liabilities to nonresidents, with an original maturity of up to and including one year;

    (ii) the outstanding use of Fund credit.

14. Excluded from foreign reserve liabilities are any liabilities arising from balance of payments support loans of maturity longer than one year, including such loans from the EU, the BIS or other international financial institutions, foreign governments or foreign banks.

15. Foreign currency-denominated liabilities to domestic residents shall include convertible currency deposits of the general government, and liabilities to banks and non-bank financial institutions, including deposits under the reserve requirement. Bank of Lithuania Litai liabilities under the currency board arrangement are defined in paragraph 4.

II. Performance Criteria on General Government Fiscal Balance, Guarantees for Domestic Borrowing, and Arrears

16. The general government encompasses the national government (comprising the state and municipal governments) and the extrabudgetary funds. The extrabudgetary funds include the Social Insurance Fund (SoDra), Health Insurance Fund, Privatization Fund, Road Fund, Ignalina Closure and Decommissioning Fund, and any other extra-budgetary operations. The central government is defined as the general government excluding municipalities.

17. The general government deficit is determined on a cash basis.

  • The overall deficit is the excess of total expenditure plus net lending over total revenue and grants. For the purpose of program monitoring, it is defined as the negative sum of (i) net domestic financing; (ii) net external financing and (iii)  net privatization receipts (Table 1).

  • Net external financing is the sum in national currency of (i) the disbursements of external loans (to the entities covered above the line or on-lent by the general government, including but not limited to budgetary organization and appropriation managers); (ii) exceptional financing (rescheduled principal plus interest if any); (iii) proceeds from bonds or other debt-related instruments issued abroad; less: (iv) amortization due (including but not limited to amortization payments of appropriation managers and budgetary organizations); and (v) changes in assets held for liquidity and/ or investment purposes outside the domestic banking system.

  • Net domestic financing is the sum of net bank financing and net nonbank financing.

    • Net bank financing is defined as the change in the banking system's claims on the general government in domestic and foreign currency, including the change in the holdings of government securities by the banking system; minus the change in balances held in the central bank and the commercial banks and other banking institutions.

    • Net nonbank domestic financing is defined as the sum of: (i) the change in the holdings of government securities by nonbanks, calculated as the difference between the change in the stock of government securities and the change in the holdings of government securities by the banking system; (ii) any net direct borrowing from nonbank institutions, including by budgetary organization and appropriation managers.
  • Net privatization proceeds are defined as the cash receipts from asset sales by the general government from abroad or domestically minus privatization-related expenditure. Expenditures necessary for, and directly related to, the privatization of state-owned enterprises shall be deducted from gross privatization proceeds and will not be classified as expenditure above the line in the fiscal accounts. These are limited to (i) outlays for consultants and advisers, (ii) increases in authorized capital prior to the sale of an enterprise, and (iii) outlays due to assuming the clean-up of environmental damages as identified in specific privatization agreements.

18. The ceiling on the general government deficit is subject to two adjusters: for faster-than-projected implementation of net lending operations and for faster-than-projected implementation of investment projects by budgetary organizations and appropriation managers.

19. For the purpose of assessing the observance of the ceilings on the general government fiscal balance, the program targets will be adjusted upwards by the amount actually disbursed and on-lent under already committed foreign loans from International Financial Institutions (including the World Bank, the EBRD, the EIB, and the NIB) and other sources of financing as specified in Table 2 are higher than the amounts assumed under the program with a 50 percent implementation rate of the total annual commitment.

20. The implementation of general government investment projects carried out by budgetary organizations and appropriation managers, including but not limited to the Ministry of Defense, is specified in Table 3 on a quarterly institution-by-institution basis. The performance criterion on the fiscal deficit will be adjusted by the amount equal to the excess of the actual appropriations over the programmed cumulative quarterly amount for every project, assuming a 50 percent implementation rate of the total annual commitment. The adjusted amount for every project for each test date shall not exceed the annual appropriation for each project based on a 100 percent implementation rate.

21. General government guarantees on domestic borrowing include all guarantee commitments for (i) borrowing in domestic currency from residents and nonresidents and (ii) borrowing in foreign currency issued for the Agricultural Marketing Agency and the Export and Import Credit Insurance Agency (Table 4).

22. Outstanding payment obligations of the general government include all identified obligations incurred by the state government, municipalities, SoDra, the Health Insurance Fund, and other extrabudgetary funds as covered by the definition of general government provided above. Outstanding payment obligations are defined as delayed payments for deliveries of goods and services when a bill has been received but not paid after 45 days. For wages and salaries, and pensions, outstanding payment obligations are defined to exist when payments are delayed by more than 7 days. Outstanding payments obligations of the central government are defined as outstanding payments obligations of the general government minus outstanding payments obligations of the municipalities outside the general government (Table 5).

III. Performance Criteria on External Debt

Ceiling on contracting or guaranteeing of external debt (i.e., debt denominated in foreign currency) with original maturities of more than one year by the public sector with a sub-ceiling on external debt with original maturities of longer than one year and including five years.

23. For purposes of this performance criterion, the public sector comprises: (i) general government (as defined in paragraph 16), (ii) the Bank of Lithuania, and (iii) other agencies on behalf of the general government (Table 6). This performance criterion applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted by the Executive Board on August 24, 2000 (Decision No. 12274-(00/85) but also to commitments contracted or guaranteed for which value has not been received. Excluded from the limits are use of IMF resources, guarantees of foreign currency-denominated borrowing of the Agricultural Marketing Agency and the Export and Import Credit Insurance Agency covered in paragraph 21, and foreign currency direct borrowing and guarantee by the municipalities from resident banks which are not guaranteed by the central government. Included are other than IMF balance of payments support from official creditors.

Ceiling on the outstanding stock of external debt (i.e., debt denominated in foreign currency) with original maturities of up to and including one year owed or guaranteed by the public sector.

24. For purposes of this performance criterion, the public sector excludes the Bank of Lithuania. The term debt has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 by the Executive Board (Decision No. 12274-(00/85). Excluded are normal import-related credits, liabilities on the correspondent accounts with central banks of the BRO (Baltics, Russia, and other countries of the former Soviet Union) countries, guarantees of foreign currency-denominated borrowing of the Agricultural Marketing Agency and the Export and Import Credit Insurance Agency covered under paragraph 21, and foreign currency direct borrowing and guarantee by the municipalities from resident banks which are not guaranteed by the central government.

25. The general government will not accumulate external payments arrears on any expenditure item or external debt as defined paragraph 23-24. Transactions subject to the ceilings specified in Section III shall be valued in the contracted currency and converted into U.S. dollars at the time the loan agreement is entered into at the exchange rate for the end of the month.

IV. Reporting

26. The authorities will provide the IMF with information needed to monitor the implementation of the program on a regular basis and in accordance with the timetable indicated below. Fund staff will review together with the authorities the data reporting on an ongoing basis and revise the reporting whenever necessary.

Information on money and banking

27. On a monthly basis, the Bank of Lithuania will provide information on:

  • international reserves;

  • the balance sheet of the Bank of Lithuania, deposit money banks, other banking institutions, and the consolidated banking survey;

  • the structure of bank assets and liabilities;

  • the currency exchange between the Bank of Lithuania, commercial banks, and the general government.

28. In line with SDDS requirements, the data on international reserves of the Bank of Lithuania will be provided to the Fund on the 5th working day after the end of the month at the latest; the balance sheet of the Bank of Lithuania will be provided to the Fund on the 10th working day after the end of the month at the latest throughout the program period in the agreed format. The other data referred to in paragraph 27 will be provided to the Fund on the 18th working day after the end of each month at the latest throughout the program period in the agreed format.

General government budget implementation and financing

29. On a monthly basis, the Ministry of Finance will provide information on:

  • below the line financing of the consolidated general government;

  • revenue of the national government (state government and municipalities);

  • on-lending operations of the general government to the nongovernment sector;

  • revenue and expenditure of all extrabudgetary funds included in the calculation of the general government financial balance;
  • outstanding domestic government debt broken down by maturity and type of debt (direct and guaranteed), including disbursements and redemption;

  • domestic debt service;

  • use of resources borrowed abroad;

  • general government deposits held abroad;

  • disbursements and repayments of foreign loans;

  • borrowing by municipal governments;
  • domestic guarantees issued during the month and the stock of outstanding domestic guarantees at the end of the month (Table 3); and

  • the stock of outstanding payment obligations of the general government, broken down by state government, municipalities, the Social Insurance Fund, the Health Insurance Fund, and each of the other extrabudgetary funds (Table 4).2

30. These data will be reported to the Fund within 30 days after the end of each month throughout the program period in the agreed format.

31. On a quarterly basis, the Ministry of Finance will provide information on:

  • state government revenues and expenditures in terms of both economic and functional classification; and

  • local government revenues and expenditures in terms of both economic and functional classification.

32. For the state government, these data will be reported to the Fund within 30 days after the end of the quarter throughout the program period in the agreed format. Data for municipalities will be reported to the Fund within 90 days after the end of the quarter throughout the program period in the agreed format.

Information on the External Sector

33. On an monthly basis, the Ministry of Finance and the Bank of Lithuania will provide information on:3

  • short-term and long-term external debt stock of the public and private sector4 including non-concessional loans from multilateral organizations; and

  • external debt service for short-term and long-term external debt of the public sector.

34. These data will be reported to the Fund within 30 days after the end of each month throughout the program period in the agreed format.

35. The above reporting requirements will be assessed on an ongoing basis, and may be revised at the initiative of the Fund and with the consent of the government and the Bank of Lithuania.

December 19, 2001

Ms. Ungulaitiene
Vice Minister of Finance
Ministry of Finance
Mr. A. Kregzde
Vice Governor
Bank of Lithuania

1The Single Treasury System will remain outside the Bank of Lithuania during the program period.
2Outstanding payment obligations of municipalities will be reported on a quarterly basis.
3The Ministry of Finance will provide data on public debt and the Bank of Lithuania will report data on private debt.
4Information on registered private sector loans will be provided on a monthly basis, actual figures for the external debt stock of the private sector will be reported on a quarterly basis.

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