Republic of Croatia and the IMF
News Brief: IMF Completes First Review of Stand-by Arrangement with Croatia
Mr. Horst Köhler
Dear Mr. Köhler:
1. We are happy to report that the macroeconomic objectives of our economic program for 2001, which is supported by the International Monetary Fund through a 14-month stand-by arrangement in an amount of SDR 200 million, are likely to be either fully met or substantially exceeded. More specifically, we are confident to achieve this year economic growth of 4 percent and reduce retail price inflation to 4.5 percent on an end-year basis, while exceeding the targeted gain of net international reserves by a large margin.
2. Although we have experienced delays in the implementation of some important measures of our program, much has been achieved and the recent parliamentary vote of confidence in the government has re-energized us to bring the implementation of our program back on track. The attached Supplementary Memorandum of Economic and Financial Policies for 2001 (the Memorandum) (i) reports on program implementation to date and on the measures we will implement in the remainder of this year in pursuit of our program objectives, and (ii) proposes the quantitative performance criteria for September 30 and December 31, 2001. In particular, the measures described in the Memorandum will allow us to keep the deficit of the consolidated central government at 5.3 percent of GDP, in accordance with the original program. The attached Memorandum supplements the Memorandum of Economic and Financial Policies that is attached to our January 31, 2001 letter to the Managing Director of the International Monetary Fund and continues to represent our policy undertakings in all respects not specifically addressed in the attached Memorandum.
3. On the basis of our performance under the arrangement so far and the policies described in the Memorandum, we request (i) waivers for the nonobservance of the performance criteria on wage policy implementation, on domestic bank borrowing and arrears of the consolidated central government, and on short-term public debt and (ii) the completion of the first review under the arrangement. In order to allow sufficient time for the preparation of relevant documents for the Fund's Executive Board, we also propose postponing the second and final review from November 30 to December 31, 2001.
4. We believe that the policies described in the attached Memorandum are adequate to achieve the objectives of our economic program, but we stand ready to take any further measures to keep our program on track. We will remain in close consultation with the Fund in accordance with the Fund's policies on such consultations. The second program review will provide one such opportunity to assess progress with program implementation and reach understandings on any measures that may be needed to achieve the program's objectives.
5. We would like to reaffirm our intention not to make the purchases that will become available under the arrangement with the completion of the present review and after completion of the second review and observance of the performance criteria for September 30 and December 31, 2001.
Attachment: Supplementary Memorandum of Economic and Financial Policies
1. We remain committed to the objectives of the economic program for 2001-03 as outlined in the Memorandum of Economic and Financial Policies attached to our letter of January 31, 2001 to the Managing Director of the International Monetary Fund. In pursuit of these objectives, we have reviewed its implementation during the first half of 2001 and adopted the policies described in Section III to achieve our program objectives in the second half of the year.
I. Recent Economic Developments and Near-Term Outlook
2. Notwithstanding the slowdown in major trading partners, the Croatian economy is growing strongly. After an expansion of 3.7 percent in 2000, the economic recovery continues and our growth objective of 4 percent for this year is likely to be achieved despite weaker external demand (Annex I). Real GDP grew by 4.2 percent year on year in the first quarter and high-frequency indicators of economic activity (retail sales, industrial production, and tourist nights) indicate that growth remained robust in the second quarter. Indications are that the third-quarter tourist season is very strong despite lingering regional tensions and some exchange rate appreciation. While private consumption remains buoyant due to larger social transfers and lower income taxes, strong imports of machinery, equipment and intermediate goods and a revival of credit to private enterprises indicate that the expected pickup of business investment is underway.
3. We also expect to achieve our inflation objective for 2001. After remaining high during the first five months of the year as a result of rising oil prices, seasonally accelerating food prices, and an increase in excise taxes, the twelve-month rate of retail price inflation fell to below 4 percent during the following two months and is expected to be no more than 4.5 percent by year end. Subdued producer price inflation and a stable core rate of retail price inflation support this expectation, notwithstanding increases in the administered prices of electricity and natural gas.
4. Our original program's international reserves target is certain to be exceeded and we have tightened our monetary program as outlined in Section III below. Despite a temporary weakening in the first half, mainly due to a surge of car imports, and the expected continued underlying growth of imports, the external current account deficit is projected to be around 3½ percent in 2001. Strong tourism receipts and the recovery of manufacturing exports support this forecast. Improved access to foreign markets, the political normalization in the region, and continued fiscal consolidation suggest that the large current account deficits of the past are unlikely to recur. This year's deficit will be more than financed by privatization receipts and government bond placements in the international capital markets. We were pleased to note that Croatia has so far remained immune to the recent turmoil in emerging market economies and that the spreads on our international bonds continued to narrow during most of this period, while the exchange rate of the kuna continued to firm, prompting the Croatian National Bank (CNB) to intervene in the foreign exchange market.
II. Program Implementation and Performance
5. Notwithstanding the delayed implementation of certain important policy measures, we are broadly satisfied with the performance under our program. All quantitative performance criteria for end-June 2001 were observed, except for the ceilings on bank borrowing and arrears of the consolidated central government and on short-term external public debt (Annex II). All three breaches were related to the delayed privatization of the telecommunication company (HT). Despite the delayed implementation of the new wage policy in the government sector, which caused the end-March structural performance criterion to be breached, we managed to observe the end-June performance criterion on the deficit of the consolidated central government by a narrow margin. By contrast, the performance criteria on net usable international reserves and net domestic assets of the CNB (and the limits on external public debt contracting and public enterprise borrowing) were observed with comfortable margins.
6. Our principal fiscal policy achievement in the first half of 2001 was the adoption of a new wage policy for government workers after the May local elections. New wage coefficients were established across most ministries and a new basic wage was set at such a level as to ensure the originally programmed 9 percent reduction of the wage bill of the consolidated central government. The late implementation of the new wage policy and the exclusion therefrom of workers in the ministries of education, science and technology, and—on a temporary basis—defense means that the wage bill in the budgetary sphere will be exceeded by some 0.2 percent of GDP in 2001, but the extension of the policy to the extrabudgetary funds (and particularly health care workers) will entail offsetting wage bill savings in the rest of the central government. . Contrary to program assumptions, however, we have not been able yet to reduce sick pay benefits, and child benefit payments are substantially exceeding their budgetary allocation.
7. Supported by exchange rate appreciation and banking system stability, the remonetization of the economy progressed faster than expected and base money demand was stronger than programmed. As banks repatriated a large part of their substantial foreign holdings to extend credit to the domestic economy, the CNB supported the easing of domestic lending rates by lowering its Lombard rate from 12 percent to 9.5 percent in March. Thereafter, with tourism inflows adding to the exchange market pressures, the CNB intervened repeatedly in the foreign exchange market, largely sterilizing its interventions through subsequent sales of CNB bills. In addition, the CNB reduced the reserve requirement rate from 23.5 percent to 22 percent and extended its base to include foreign currency loans. This measure, which was phased in during June-July, served to increase the supply of kuna while increasing the demand for foreign exchange.
8. As noted, we experienced delays with the second phase of privatizing HT. In the face of depressed international stock market valuations, we decided to postpone the initial public offering of at least 20 percent of the company's shares, but instead reached agreement with Deutsche Telekom in July on the sale of 16 percent of the company's capital, raising Deutsche Telekom's stake in HT to 51 percent. Privatization advisors have been appointed for the power (HEP) and oil (INA) companies and five laws on energy sector reform were approved by parliament in July, with the law on energy services regulation taking effect immediately.1 Other important reforms introduced so far include the introduction of a single treasury system for all government ministries in January 2001 and its extension to the pension fund at midyear, the amendment of the foreign exchange law, a new central bank law, and a new law on local and district self-government. Drafts of a new banking law and a health reform law have also been prepared.
9. We remain committed to the reduction of the deficit of the consolidated central government to 5.3 percent of GDP as the centerpiece of our economic program for 2001. Although at 5.7 percent of GDP the deficit in 2000 turned out to be lower than expected, this represents an adjustment effort of 3.9 percent of GDP as tax reductions during 2000 and at the start of 2001 are lowering this year's revenue ratio by 2.3 percent of GDP and court-mandated special pension payments are adding 1.2 percent of GDP to the expenditure ratio. The central government budget was amended at midyear to bring pension fund operations on the budget and to replace expenditure devolved to the local governments by transfers of the taxes earmarked for this purpose. The revised budget also reduced privatization receipts from 5.2 percent of GDP to 4.0 percent of GDP, with an attendant increase in foreign borrowing. When making these changes, we realized, however, that slippages on the expenditure side, mainly related to much higher than budgeted child benefits, the postponement of health sector reform, and unforeseen additional recapitalization of the state-owned postal bank (HPB), required additional fiscal measures to prevent the deficit from exceeding 5.3 percent of GDP.
10. With a shortfall in excise tax collections being offset by higher value added taxes, total revenue is projected to remain fully in line with our original program.2 As we are committed to reducing the burden of taxes and social contributions in future years, we have, with the exceptions noted in footnote 2, ruled out revenue increases to achieve our deficit target in 2001. Instead, almost the entire adjustment will be achieved through expenditure reductions.
11. Based on an estimated adjustment need of 0.8 percent of GDP, we have decided on the following expenditure cuts (Box). As part of our preparation of the budgets for 2002 and 2003 and of a comprehensive attempt to rationalize our ill-coordinated system of social transfers, we are preparing amendments to eleven laws that will reduce spending on special pensions, child benefits, disability and home care allowances, maternity leave, and sick pay by about 1.4 percent of GDP annually on a permanent basis.3 The effect of these measures, which are expected to be adopted by parliament in September, during the remainder of this year will be almost 0.6 percent of GDP. New labor and defense laws will also be sent to parliament in September, and we expect additional savings, especially from layoffs of military service staff, during 2002-03. Additional expenditure savings of almost 0.4 percent will be achieved during the remainder of 2001 through discretionary cuts of spending on goods and nonwage services, subsidies, and capital investment that are being implemented with immediate effect. We are confident that these measures, which should produce somewhat more than the adjustment required, will limit the fiscal deficit to 5.3 percent of GDP; but we will in any case take any additional measures needed to avoid exceeding this limit in 2001. Performance criteria for end-September and end-December have been established to this effect (Annex IV). A revised budget incorporating all these measures will be sent to parliament in September. Approval of the eleven law amendments and of the revised budget will be a prior action for the completion of the first review (Annexes III and IX).
12. As noted, our revised financing plan for 2001 envisages privatization receipts equivalent to 4.0 percent of GDP. More than one half of that amount is expected to be realized in September from the recent agreement to sell 16 percent of HT's shares to Deutsche Telekom. The remainder will be ensured by the privatization of Croatia Banka and Dubrovačka Banka, for which final bids are expected in October, and by a combination of options that include the privatization of the insurance company, the public sale and sale to employees of additional shares of HT, and the sale of residual government share holdings in previously privatized banks and companies.4 Net foreign borrowing will rise to 2.3 percent of GDP with the recent augmentation of the € 500 million euro bond by € 250 million and expected EFSAL (DM 80 million) and SAL (US$100 million) disbursements from the World Bank. The residual domestic financing surplus of 1.0 percent of GDP will be used almost entirely for arrears reduction. In the remainder of the year, the government will retire a portion of outstanding Treasury bills and replace them with medium-term euro-denominated domestic bonds. Performance criteria for net bank borrowing and arrears of the consolidated central government have been established (Annex IV). Similarly, performance criteria have been established in the form of ceilings on short-term external public debt and the contracting and guaranteeing of nonconcessional external public debt with a maturity of more than one year (Annex V).
13. We have begun to decentralize primary and secondary education, primary health care, and retirement homes, initially limiting the local governments' financial responsibility to the maintenance of physical infrastructure and spending on materials. The resources earmarked for the local governments to defray these expenses are being transferred from the central government budget. Advice from a Fund technical assistance mission in September will be used in the further implementation of our decentralization plans. Under recently approved legislation, the local authorities have been empowered as from January 1, 2002 to raise their own resources to supplement the budgetary transfers. With the growing fiscal responsibilities of the local authorities, we realize the importance of timely information on their fiscal operations. We will therefore develop by the end of this year a plan to accomplish timely reporting in a GFS format within the shortest possible delay. We will also ask the privatization fund (HFP), the highway construction agency (HA), and the development bank (HBOR) to report their operations quarterly in a GFS format.
14. To facilitate the maintenance of an unchanged nominal wage bill in 2002-03 while creating room for some wage increases, it is important to eliminate excess government sector employment. The largest pockets of excess employment reside in the Ministries of Interior and Defense, and staffing levels were reduced by some 750-775 in each of them by midyear. Another 3,600 employees will be laid off in the Ministry of Interior starting in August 2001, whereas 5,000 people are expected to be laid off in the fourth quarter of 2001 following parliamentary approval of the new defense law. Together with small net reductions in other ministries, we expect to achieve an aggregate net employment reduction in the central government of some 10,000 by end-2001. We reconfirm this target as a performance criterion under the arrangement for end-December 2001. Once severance payments have been exhausted, there will be room for wage increases next year. World Bank resources will be used to retrain laid-off workers.
15. To fully exploit the potential of the new treasury system, we have reorganized the Ministry of Finance to improve reporting to the treasurer. All central budget expenditure (including since July pension spending and routine items of all budget users) is now authorized and certified by the treasury and separate ministerial accounts are being closed. With the closure of these accounts, which is expected by end-2001, and the inclusion of own income of all budget users in the central budget from January 1, 2002, all payments will be effected by the treasury and arrears data will be automatically compiled. With the introduction of health care reform on January 1, 2002, health spending will also be channeled through the treasury.
16. The startup of operations of the central registry of affiliates (REGOS) and the regulatory authority for private pension funds (HAGENA) will allow us to proceed with the introduction of the mandatory second pension pillar on January 1, 2002. To this effect, we have established a project implementation unit in the Ministry of Labor that is supported with World Bank funds. We currently estimate the fiscal transition cost of introducing the second pillar at 1.3-2.0 percent of GDP in 2002, depending on how many of the 40-50 year age bracket will choose to participate in the second pillar. The voluntary third pillar is expected to be available before end-September 2001.
B. Monetary Policy and Financial Sector Reform
17. The new central bank law enshrines price stability as the CNB's primary objective. Accordingly, monetary and exchange rate policy will be used primarily to reduce the twelve-month rate of retail price inflation to 4.5 percent at the end of 2001, assuming no further increases in administered prices beyond those currently envisaged. This inflation objective as well as economic growth of 4 percent, a further small decline in velocity, and a more ambitious international reserves target underlie the revised monetary program for 2001, which leaves room for an expansion of credit to the nongovernment sector of 5¼ percent in the second half of 2001, or 17¼ percent for 2001 as a whole. These resources, an improved margin for self-financing, government arrears repayment, and foreign market borrowing by larger companies should provide ample financing to sustain the recovery of output and investment in the second half of 2001. To ensure that the envisaged room for credit expansion to the nongovernment sector is not pre-empted by public enterprise borrowing, we have established quarterly limits on net bank borrowing by 10 large public enterprises. These limits will be a performance criterion under the arrangement (Annex VI).
18. Within the constraints imposed by its revised monetary program, the CNB intends to rely on intervention rather than interest rate policy to address the customary weakening of base money demand after the tourist season. To the extent allowed by liquidity conditions, the CNB will consider a further moderate reduction in reserve requirements this year, in line with its desire gradually to lower reserve requirement ratios to internationally practiced levels. In light of the large overperformance in the first half of 2001, the CNB has raised its annual target for the increase in net usable international reserves and adjusted accordingly the quarterly floors for net usable international reserves, which constitute performance criteria under the arrangement, for the remainder of this year (Annex VII). Concurrently, it has adjusted the net domestic asset ceilings, which are performance criteria under the arrangement and will guide the CNB in the implementation of its monetary policy in the remainder of 2001 (Annex VIII). Should base money demand be weaker than assumed in the CNB's program, the CNB will tighten liquidity and thereby reduce net domestic assets sufficiently to ensure that its revised international reserve targets are observed. If, however, base money demand turns out to be stronger than assumed, the CNB will consult with the Fund to determine if the inflation outlook warrants an unsterilized buildup of international reserves.
19. With the privatization of Croatia Banka and Dubrovačka Banka, almost 88 percent of banking assets will be controlled by foreign owners. With the exception noted in paragraph 20, we consider the banking system fully recovered from the 1998-99 crisis and have strengthened banking supervision to prevent a recurrence. One small bank and two savings institutions were closed during 2001 and their insured deposits have been paid out promptly with deposit insurance funds. We are now considering to limit the existing insurance cover of up to HrK 100,000 per deposit to time and savings deposits, but an eventual increase of the insurance limit to the EU norm remains our longer term objective.
20. The financial situation of the state-owned postal bank (HPB) needs early resolution. The bank, which accounts for 2.1 percent of bank assets and has insured deposits, mostly from small depositors, equivalent to 0.6 percent of GDP, has received budgetary support equivalent to 0.5 percent of GDP in 2001 to restore compliance with the statutory capital adequacy ratio. With the breathing room provided, the government is now examining its options, including the bank's privatization, and will adopt a firm decision on the bank's future by end-2001, as envisaged in the original program.
21. A new securities law will be submitted to parliament by end-September 2001, with approval expected by year-end.
IV. The Program for 2002-03
22. Our broad objectives for 2002-03 remain unchanged: a modest acceleration of growth in the context of moderating inflation and a small external current account deficit. The principal precondition for their achievement is continued fiscal consolidation. In this respect, we reconfirm our commitment to reducing both the fiscal deficit and the government expenditure ratio. More specifically, we are in the process of preparing budgets for 2002 and 2003 that aim at reducing the deficit of the consolidated central government to 4.25 percent of GDP in 2002 and further to 1.4 percent of GDP in 2003, with a decline in the expenditure ratios to some 41 percent and 38 percent, respectively, of GDP. We expect to mobilize sufficient resources from the privatization of HEP, INA and the oil pipeline (JANAF) to allow the reduction of the public debt-to-GDP ratio from 48.6 percent in mid-2001 to 42.7 percent by end-2003. The budget for 2002 will be discussed with the Fund during the second review under the present arrangement.
The above listed ceilings on the cumulative deficit of the consolidated central government cover: (i) central government operations, that is, the central government budget (the Office of the President, the parliament, the government, the constitutional court, all ministries, other independent state administration and judicial bodies); (ii) existing central extrabudgetary funds (health, pension, employment, child benefit, and water management funds); and (iii) the proposed Fund of Assets for Investment Promotion and Fund for the Creation of New Jobs and Re-training. The government will not establish new extrabudgetary funds during the program period, but any such funds would be covered by the ceilings.
The ceilings do not include the net borrowing of the Croatian Bank for Reconstruction and Development (HBOR), the Deposit Insurance and Bank Rehabilitation Agency (DAB), and the Croatian Privatization Fund (HFP). Their net borrowings during the first half of 2001 were HrK 259 million for HBOR, HrK 56 million for DAB, and HrK 42 million for HFP. HBOR's net borrowing in the second half of 2001—defined as the change in gross liabilities minus the change in total loans—is projected to be a negative HrK 1.2 billion and will be monitored under the program. There will be no new borrowing by DAB or HFP in the second half of 2001. At any rate, their borrowing, which will also be monitored under the program, would be excluded from the ceilings.
For purposes of the program, the deficit will be defined on a cash-adjusted basis (i.e., on a cash basis adjusted by the net change in arrears). The cost for recapitalizing banks or the payment of insured deposits will be considered as "above the line." The following will be considered as "below the line": privatization receipts, payment of arrears, payment of promissory notes issued by the Ministry of Finance and the Health Fund, bonds issued including those for financing the recapitalization of banks or paying out insured deposits, redemption of government bonds tendered by the CNB in connection with bank resolution, and any release of foreign-held blocked foreign assets of the former SFRY to the government.
The limit on the deficit of the consolidated central government will be adjusted downward to offset the net effect of any reduction in interest payments attributable to rescheduling of existing government debt.
All currency conversions will be done using December 30, 2000 exchange rates (in HrK per unit of foreign currency) as follows:
The quarterly limits will be monitored from below the line on the basis
of data provided monthly by the Ministry of Finance and the CNB within
30 days. For purposes of monitoring compliance with the ceilings, the
cumulative difference since July 1, 2001 between road tolls collected
by the budget and one fourth of excise taxes on fuel collected by Croatian
Highways (HA) will be added to these data. Both data series will be provided
by the Ministry of Finance within 30 days of the end of such calendar
quarter. Net borrowing by HBOR and new borrowing by DAB and HFP will be
reported quarterly by the CNB within 30 days.
II. Limits on the Cumulative Increases in the Net Credit
The quarterly limits are cumulative. The consolidated central government is as defined in Section I above.
For program purposes, net credit of the banking system to the consolidated central government is defined as all claims of the banking system on the consolidated central government less all deposits of the consolidated central government with the banking system.
The ceiling for September 30, 2001 will be lowered by the equivalent of US$360 million, if the envisaged repayment of this amount to settle the prefinancing by foreign banks of the sale of 16 percent of shares in the telecommunications company (HT) is delayed beyond the third quarter. The ceiling for September 30, 2001 will also be adjusted upward by the equivalent of the amount by which the sum of privatization receipts from the sale of 16 percent of HT shares in July 2001 (€ 500 million or US$466 million at the applicable program exchange rates) and the disbursements of the amounts retained in an escrow account from the sale of 35 percent of HT shares in 1999 (US$46 million) will fall short of the expected US$512 million.
Data on banking system claims on and liabilities to the consolidated central government are taken from the balance sheets of the banks and the CNB, and will be provided monthly to the Fund by the CNB within 30 days. For purposes of monitoring compliance with the ceilings, the cumulative difference since July 1, 2001 between road tolls collected by the budget and one fourth of excise taxes on fuel collected by Croatian Highways (HA) will be added to these data. Both data series will be provided by the Ministry of Finance within 30 days of the end of each calendar quarter.
III. Limits on the Arrears of the
Arrears include: (i) all payments overdue according to their original or modified terms; and (ii) any promissory notes issued by the Ministry of Finance and the central extrabudgetary funds. The stock of arrears will be provided monthly to the Fund by the Ministry of Finance within 30 days.
Ceilings on the Stock of Short-Term External Public
For program purposes, the term debt has the meaning set forth in point No. 9 of the IMF Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 (Executive Board Decision No. 12274-(00/85)). However, for the time being lease contracts will not be covered by the ceilings. A reporting system for lease contracts is currently being set up by the Ministry of Finance. Once functional, leases will be included in the debt contracting ceilings.
The short-term debt limits do not apply to normal import-related credits.
The ceilings on medium- and long-term debt apply to the contracting or guaranteeing of new nonconcessional external debt with an original maturity of more than one year, and, within this limit, with an original maturity of more than one year and less than 5 years. Concessional loans are defined as those with a grant element of at least 35 percent, using currency-specific discount rates based on the six-month average commercial interest rates reported by the OECD (CIRRs) for loans with maturities of less than 15 years, and on the 10-year average CIRR for loans with maturities of 15 years and more.
The public sector comprises the consolidated central government as defined in Annex IV.I, the CNB, DAB, HBOR, HFP, the 10 large public enterprises listed in Annex VI, and the lower levels of government. Excluded from the limits are performance guarantees on the construction of ships (for no more than the value of advance payments), and changes in indebtedness resulting from refinancing and rescheduling, including the capitalization of interest in arrears.
The above limits also do not apply to guarantees by the central government for suppliers' credits related to imports for constructing ships during the period until delivery of the ships takes place. In case of orders for multiple ships, the import related credits could take the form of revolving external credit lines. To monitor such guarantees, data on the guarantees extended for ship building, including performance guarantees or bonds, and the payments and deliveries for ships built with these guarantees will be supplied on a quarterly basis.
Debt falling within the limits shall be valued in U.S. dollars at the exchange rates prevailing at the time when the debt is contracted.
Information on the contracting and guaranteeing of new external debt and on the stock of short-term external debt outstanding falling both inside and outside the limits will be reported monthly to the Fund within 30 days by the CNB.
The September 30, 2001 ceiling on the stock of short-term external public debt will be adjusted upwards by US$360 million if the transfer of the receipts from the sale of 16 percent of HT shares to the Croatian government accounts is delayed beyond end-September. In accordance with footnote 3 of paragraph 12, the December 31, 2001 ceiling on the stock of short-term external public debt will be raised by the amount of any bridge financing of future privatization receipts.
Limits on the Cumulative Increases in the Net Credit
These aggregate limits cover the 10 enterprises listed below. Net credit is defined as the sum of all short-term and long-term bank claims in local and foreign currency on these enterprises by banks resident in Croatia plus the amount of credit guaranteed by Croatian banks from domestic nonbank and foreign sources, less the sum of these enterprises' total deposits in local and foreign currency with such banks. Credit guaranteed by the government or resulting from the calling of performance guarantees will be excluded from the ceilings to the extent that it is not already reflected in the balance sheets of the banks.
The 10 enterprises are as follows:
1. Hrvatska Elektroprivreda, Zagreb (Croatian Electricity Company)
Enterprises on the above list that are privatized in the course of the arrangement will be removed from the limits and the limits will be adjusted downward by the amount of the net credit outstanding to those enterprises at the end of the month preceding privatization. Whenever changes in accounting practices or the set of enterprises reporting to the CNB result in changes in the data series, the Fund will be notified and provided one quarter of data calculated with both the old and new definitions and an offsetting adjustment will be made to the limits. The limits will be adjusted downward by the amount of any bank or enterprise rehabilitation that writes off or removes these assets and liabilities from the banking system or any debt-equity swaps that convert bank debt into equity in the enterprises. Information regarding such debt-equity swaps will be provided by the Ministry of Economy if and when they occur.
The above maximum changes will be cumulative and will be monitored on the basis of December 30, 2000 exchange rates (as listed in Annex IV.I) from data collected monthly by the Ministry of Finance (ORESE) and supplied to the Fund within 30 days.
Targets for Cumulative Increases in the Net Usable
For purposes of the program, net usable international reserves of the Croatian National Bank (CNB) are defined as the U.S. dollar value of gross foreign assets minus reserve assets held against foreign currency deposits by domestic banks and against CNB foreign exchange bills minus gross foreign liabilities minus off-balance sheet foreign currency obligations.
For purposes of the program, gross foreign assets shall be defined as monetary gold, holdings of SDRs, any reserve position in the IMF, and holdings of foreign exchange in convertible currencies by the CNB (the accounting values of exchange rates and SDRs are specifically defined below for program purposes). Any return to the CNB of blocked foreign assets that are not part of CNB foreign assets as of June 30, 2001 will be added to the reserve floor. Reserves that are pledged, frozen, or used as collateral shall be excluded from the gross foreign assets. In particular, any reserve assets pledged to secure government debt will be excluded from the reserves definition.
For purposes of the program, reserve liabilities shall be defined as all liabilities of the CNB to nonresidents—excluding deposits into the special accounts for external debt servicing—with an original maturity of up to and including one year, as well as liabilities arising from IMF purchases and bridge loans from the BIS, irrespective of their maturity. For purposes of the program, reserve liabilities shall also include guarantees provided by the CNB backed by reserves as collateral.
The net forward position of the CNB is defined as the difference between the face value of foreign currency-denominated CNB off-balance sheet claims on nonresidents (forwards, swaps, options, and futures market contracts) and foreign currency obligations to both residents and nonresidents. This position amounted to US$0 million on June 30, 2001. For program purposes, only the off-balance sheet obligations will be deducted from the CNB's net international reserves position. These liabilities amounted to US$0 million on June 30, 2001.
The floor on net usable international reserves for September 30, 2001 will be adjusted upward by US$400 million, if the envisaged repayment of this amount to settle the prefinancing of the sale of shares in the telecommunications company (HT) is delayed beyond the third quarter. This floor will be adjusted downward for the amount by which the sum of privatization receipts from the sale of 16 percent of HT shares in July 2001 (€ 500 million or US$438 million at the applicable program exchange rates) and the disbursements of the amount retained in an escrow account from the sale of 35 percent of HT shares in 1999 (US$46 million) will fall short of the expected US$484 million as of September 30, 2001.
For program purposes, the accounting exchange rates are equal to the mid-points of the exchange rates obtaining on December14, 2000. For the five most important currencies and the SDR, these exchange rates were (in kuna per unit of foreign currency):
The limits will be monitored from data on the accounts of the CNB supplied monthly to the Fund by the CNB within 15 days.
Limits on the Cumulative Increases in the Net Domestic
The net domestic assets of the Croatian National Bank (CNB) are defined as the difference between the base money and the net usable international reserves of the CNB (as defined for program purposes in Annex VII), both expressed in local currency at program exchange rates. Base money is defined as currency outside banks, vault cash of banks, giro and required reserve deposits of banks in domestic currency, and deposit money held at the CNB.
The limit for September 30, 2001 will be lowered by the equivalent of US$400 million, if the envisaged repayment of this amount to settle the prefinancing of the sale of shares in the telecommunications company (HT) is delayed beyond the third quarter. This limit will be adjusted upward by the equivalent of the amount by which the sum of privatization receipts from the sale of 16 percent of HT shares in July 2001 (€ 500 million or US$438 million at the applicable program exchange rates) and the disbursements of the amount retained in an escrow account from the sale of 35 percent of HT shares in 1999 (US$46 million) will fall short of the expected US$484 million as of September 30, 2001.
The CNB's policies in response to the intentions expressed in the final two sentences of paragraph 18 will be assessed in relation to the base money projections of HrK 13,605 million for September 30, 2001 and HrK 14,087 million for December 31, 2001. The limits and base money projections will be monitored from data on the accounts of the CNB supplied monthly to the Fund by the CNB within 15 days.
Prior Action for Completion of the First Review of
As noted in paragraph 11 and in Annex III, amendments of eleven laws securing fiscal savings of at least 0.4 percent of GDP in 2001 and at least 1.0 percent of GDP on an annual basis and of a revised budget for 2001 securing a deficit of the consolidated central government of no more than 5.3 percent of GDP in 2001 in accordance with the program definition is a prior action for concluding the first review under the stand-by arrangement. The eleven laws to be amended are the following:
1 We expect a one-quarter delay in the parliamentary approval of the two privatization laws for HEP and INA, respectively. Both laws are currently being prepared in the Ministry of Economy and will be submitted to parliament by end-September. Parliamentary approval is now expected by end-December 2001, compared with the end-September 2001 structural benchmark under our original program.
2 For program purposes, the revised revenue projection has been reduced by the equivalent of 0.1 percent of GDP to account for the failure of the central government to transfer to the new highway construction agency (Croatian Highways) the full amount of revenue envisaged in the original program.
3 Some of the savings, such as those arising from the lowering of the income tax threshold for pensions and the increase in copayments for medicines and medical services, will accrue on the revenue side.
4 In the unlikely event of shortfalls, we will seek external bridge financing of future privatization receipts.