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

La Paz, Bolivia
April 8, 1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Camdessus:

1. The Bolivian Government has developed its economic program for 1999, which is explained in the attached Memorandum of Economic Policies. We would like to note that requesting bids for the privatization of the state petroleum company (YPFB) by February 1999 was a structural performance criterion under the first annual ESAF arrangement. We are requesting a waiver of this structural performance criterion because of delays related to the need to coordinate the sale of all remaining assets of YPFB.

2. We believe that the policies and measures set forth in this memorandum are adequate to achieve the objectives of our program, but will take any other measures necessary for this purpose. During the period of the arrangement, the government will consult with the Managing Director, on its own initiative or at the request of the Managing Director, concerning the adoption of appropriate measures.

3. On this basis, we are requesting the completion of the midterm review under the first annual ESAF arrangement and the second disbursement of SDR 16.8 million.

Sincerely yours,

Herbert Muller Costas
Minister of Finance
Juan Antonio Morales
Central Bank




I.  Introduction

1.  This memorandum provides a brief update of our economic policy memorandum of August 27, 1998 (which sets out Bolivia's economic program for 1998-2001) by reviewing economic developments in 1998 and explaining in more detail the government's economic program for 1999.

II.  Economic developments in 1998

2.  The 1998 economic program aimed at reducing inflation to 6.5 percent following a sharp increase at end-1997 in excise taxes on domestic sales of petroleum products, achieving an economic growth rate of 4.5 to 5 percent, and holding net international reserves constant, with a view to keeping the international reserve cushion at six and a half months of imports. The program also envisaged that the external current account deficit would stay at somewhat over 8 percent of GDP in 1998, financed by a surge in foreign direct investment (FDI) that had been triggered by the reforms adopted since 1985. The combined public sector deficit was to rise from 3.3 percent of GDP in 1997 to 4.1 percent of GDP in 1998, even with a substantial increase in excise taxes, because the cost of structural reforms, particularly the 1996 pension reform, was projected to rise from 3 percent of GDP in 1997 to over 5 percent of GDP in 1998 (Table 1). Credit policy was to remain tight, while exchange rate policy would continue to preserve external competitiveness. Structural measures included making the preparations to bring the refineries of the state petroleum company (YPFB) to the point of sale, privatizing the state smelting company (Vinto), improving governance through judicial and customs reform, continuing the process of strengthening financial sector supervision and beginning a dialogue on labor market modernization.

3.  Economic policies remained strong in 1998, and all performance criteria for end-December 1998 were observed. The fiscal revenue effort improved considerably, owing in part to a successful program to collect back taxes on contraband vehicles. However, structural reform costs rose as expected and the fiscal deficit amounted to 4 percent of GDP. With regard to credit policy, net domestic assets contracted by significantly more than expected. In the area of structural reform, the government, with the assistance of the Fund's Fiscal Affairs Department, developed a plan for comprehensive customs reform to eliminate the widespread evasion of customs duties. As part of this effort, some senior staff of the customs administration were replaced, and a long term external advisor on customs reform was appointed. In other areas, an insurance law was approved by congress, most of the reserve requirement on financial institutions was converted into a liquid asset requirement, and a regulation was adopted that phased in a substantial increase in bank provisions over the next five years. The Law of Popular Credit and Property approved in June 1998 established a system of consolidated financial system supervision, reformed the administration of public utility cooperatives, expanded access to microcredit and set in motion the creation of a national identification system (RIN).

4.  The turmoil in international financial markets had little direct impact on domestic financial conditions, which remained broadly stable in 1998. Nonetheless, the effect of these difficulties is being felt through the terms of trade, as the world prices of Bolivia's exports have declined by over 20 percent since the onset of the crisis in Asia.

5.  In 1998, underlying economic growth is estimated at around 5.5 percent, as the reforms since 1985 have led to rapid growth in key sectors, although actual growth is estimated at 4.7 percent, owing to the one-time effects of El Niņo. Consumer price inflation fell to 4.4 percent by December 1998, benefitting from transitory factors (the decline in world oil prices and moderate food price inflation) as well as the stance of demand policies; nonenergy nonfood inflation amounted to somewhat over 6 percent. The decline in world oil prices was able to feed through into consumer prices because of the introduction in December 1997 of an automatic link between domestic and world petroleum prices. The external current account deficit widened from 7 percent of GDP in 1997 to 7.9 percent of GDP in 1998. Exports fell somewhat, reflecting both lower prices as well as slow growth in volumes. Imports rose by 30 percent in the first half of the year, but then fell by 8 percent in the second half. With foreign direct investment--mainly into oil and gas exploration and telecommunication--rising to over 10 percent of GDP (US$870 million), net international reserves increased by about US$125 million, bringing gross international reserves to the equivalent to seven and a half months of imports and 130 percent of short-term liabilities of the central bank. Bolivia's external debt burden improved further, following the provision of debt relief under the HIPC Initiative of about US$700 million in net present value terms.

III.  Economic Program for 1999

6.  The economic program for 1999 fits into the medium-term program, which seeks to achieve a substantial reduction in poverty by fostering economic growth of 5.5 to 6 percent a year by early next decade and taking steps to distribute the benefits of growth more equitably. The specific economic objectives for 1999 are to encourage economic growth of 4.5 to 5 percent and limit inflation to 5.5 percent. We will allow a moderate loss of net international reserves in line with the objective of maintaining an international reserve cushion of about six and a half months of imports and somewhat above 100 percent of short-term liabilities of the central bank.

A.  Fiscal Policy

7.  Fiscal policy will stay on the medium-term path to gradually offset the sharp rise in the cost of structural reforms since 1996 and to reduce the fiscal deficit to around 2 percent of GDP in 2002, a level that can be financed entirely by concessional external financing. This approach will gradually reduce the government's need to borrow from the private pension funds, and will leave these resources free to finance private activity. In the coming years, the government will analyze the structure of public revenues, drawing on the advice of the recent technical assistance mission on tax policy from the Fund's Fiscal Affairs Department.

8.  For 1999, the combined public sector deficit is targeted to decline to 3.9 percent of GDP (Tables 2 and 3). The nonpension balance will improve to a surplus of 0.3 percent of GDP (the level contemplated in the program), as net pension costs rise to 4.2 percent of GDP, instead of declining to 3.9 percent of GDP as expected.1 Net concessional external financing will amount to 2.9 percent of GDP, with net domestic financing of 1 percent of GDP (compared with pension fund savings of 1.7 percent of GDP). Net domestic financing will be adjusted upwards to a maximum of 1.3 percent of GDP, in the event of a shortfall in external financing.

9.  Total revenues are projected to rise slightly in relation to GDP, reflecting several different factors. Tax revenues are expected to remain broadly stable in relation to GDP, as customs reform and the ongoing efforts to improve domestic tax administration offset most of the effect of the loss of the one-time collection of back taxes. In particular, the customs reform is expected to yield additional collections of customs duties, VAT on imports, and other taxes of 0.5 percent of GDP in 1999. The operating balance of public enterprises is still expected to improve by 0.7 percent of GDP, as severance payments will fall to virtually zero as the process of restructuring major public enterprises will be finished in mid-1999, and grants are expected to rise in relation to GDP. Both nontax revenues and operating profits of the central bank are projected to decline in relation to GDP.

10.  Our revenue projection currently assumes that net privatization proceeds are zero and that other capital revenues are 0.1 percent of GDP. If the government receives privatization proceeds from the sale of the residual of YPFB, Vinto or other public enterprises, the government will spend up to US$45 million of its capital revenue (which would include privatization proceeds) on public investment, particularly on roads, and capital revenues in excess of US$45 million will be used to reduce the fiscal deficit.

11.  Total nonpension spending is projected to fall by 0.5 percent of GDP, reflecting a similar decline in current spending in relation to GDP. The government has adopted a very prudent wage policy to help limit inflationary pressures. The general government's wage bill is expected to decline in relation to GDP, based on the recent agreement to grant an average wage increase of 4 percent (ranging from 6 percent for those earning below Bs 600 per month to no increase for those earning above Bs 3,000 per month and some additional increases for teachers). Interest payments will also fall owing to relief under the HIPC Initiative. Other current spending on reforms in health, education and other sectors will rise in relation to GDP, financed in part with resources coming from lower interest payments resulting from debt relief under the HIPC Initiative. This spending also includes the backpayment of all overdue tax rebates to exporters.

12.  Public investment will rise somewhat to 6.5 percent of GDP, with an emphasis on public sanitation, and the ongoing reforms of the education, health and judicial systems. In addition, we will intensify our focus on improving the maintenance and construction of the road network, which has been badly damaged by recent heavy rains. A better road system will help lower transport costs, which will benefit exporters and other producers.

B.  Monetary Policy

13.  Broad money is projected to grow at the same pace as in 1998 (13.5 percent), continuing to rise gradually in relation to economic activity, and the degree of dollarization of the financial system is expected to remain broadly the same as last year. The central bank will expand its net domestic assets no more than by the equivalent of 25 percent of outstanding currency issue at the beginning of the year, consistent with the targeted loss of US$50 million for net international reserves and a growth in currency issue slightly faster than the growth in nominal GDP (Tables 4 and 5). Net central bank credit to the public sector will not exceed minus Bs 70 million. This credit policy is expected to be consistent with an expansion in bank credit to the private sector of about 14 percent, compared with 24 percent in 1998.

C.   External Sector

14.  The external current account deficit is projected to decline to about 7 percent of GDP in 1999, as the construction phase of the gas pipeline to Brazil ends and the gas exports come on stream. Export prices, on an annual average basis, are expected to decline further this year, and then begin to recover gradually starting in 2000. We expect foreign direct investment in mining, energy, and other export products to remain strong in the coming years, although below the levels observed during the construction of the gas pipeline. As exports from the mining and other sectors come on stream, and as gas and oil exports rise further, the external current account deficit is projected to decline to less than 6 percent of GDP by early next decade. Because these deficits are expected to be financed mostly by foreign direct investment, the central bank will be able to maintain the international reserve cushion at about six and a half months of imports. To ensure that Bolivia's external debt remains manageable, we will continue to restrict new nonconcessional external borrowing by the public sector (Table 6). We will conclude agreements with Paris Club creditors under the HIPC Initiative by June 30, 1999 and will secure debt relief on comparable terms from non-Paris Club bilateral creditors. We will not incur external payments arrears during 1999.

15.  Bolivia's external sector remains vulnerable to adverse developments in the world economy, including the recent decline in export prices. The government will continue to adapt fiscal policy as necessary to keep the external current account deficit on a sustainable path. Bolivia's exchange rate policy has promoted a significant diversification of exports in the past decade, and it will continue to be directed at keeping the economy on a competitive footing.

D.  Structural Reforms

16.  The government remains committed to the agenda of structural reforms described in our August 1998 economic policy memorandum (Table 7). In 1999, we place the highest priority on implementing the following reforms:

  • The state petroleum company (YPFB): Bids to purchase the refineries are to be requested in April 1999. The refineries are expected to be privatized by August 1999, and we understand that this action will be a prior action for the next annual ESAF arrangement. The privatization of YPFB's natural gas network, jet fuel stations and natural gas bottling plants will also be completed by August 1999.

  • The state smelting company (Vinto): We will attempt to privatize this enterprise by May 1999; if this effort does not succeed, we will liquidate Vinto by September 1999.2 Either the privatization or liquidation of Vinto will be another prior action for the next annual ESAF arrangement.

  • Financial sector: The government will present to congress in the coming months a financial sector reform law that will establish a system of deposit insurance and strengthen procedures to deal with problem banks.

  • Fiscal decentralization: The government will strengthen the current system of decentralization to reduce the risk of losing fiscal control and to improve the quality of public investment. In 1998, the congress tightened the limits on the indebtedness of local governments, and the government introduced new bank regulations to require banks to observe such debt limits and established penalties for noncompliance of the new norms on budget and borrowing by local governments. From January 1999, those municipalities that have already breached the current debt limits have been barred from taking on additional debt until they come back into compliance with the limits.

  • A medium-term plan will be put in place to implement the recommendations of the FAD mission on more fundamental changes to the budget and accounting frameworks of local governments (December 1999) and the reassignment of the expenditure responsibilities of local governments (mid-2000).

  • Tax administration: Amendments to the tax code will be submitted to congress by June 1999 to make tax collection more efficient and to improve the enforcement of the tax laws.

  • Customs reform: The most important aspect of this reform in 1999 will be the passage of the new customs law and the adoption of the related regulations by June 1999.

1The 1996 pension reform law entitles men who were over 55 years of age and women 50 years of age (the retirement ages under the old system) in December 1995 to their pensions from the old social security system when they choose to retire. For this reason, there are about 20,000 new retirees under the old system in 1999.
2Attempts to privatize Vinto in June 1997 and December 1998 were unsuccessful.


Table 1. Bolivia: Annual Fiscal Cost of Structural Reforms
(In percent of GDP)
        1995       1996       1997 Prel.

Total costs 1.0 1.5 3.1 5.4 5.6
   One-time costs 0.8 1.1 0.8 0.9 0.5
   Recurrent costs 0.3 0.3 2.3 4.5 5.2
Pension reform (incremental cost from 1996) 0.0 0.0 1.4 2.8 3.0
YPFB capitalization 0.0 0.0 0.7 1.2 1.3
   Balance of YPFB 0.0 0.0 0.4 0.7 0.7
   Change in royalties 0.0 0.0 0.2 0.5 0.5
Severance payments 0.4 0.7 0.6 0.7 0.3
   General government 0.2 0.4 0.2 0.4 0.1
   Enterprises 0.2 0.3 0.4 0.4 0.1
Cost of increased remuneration for bank reserves 0.0 0.0 0.0 0.1 0.2
Judiciary reform and governance 0.0 0.0 0.0 0.1 0.2
Customs administration reform 0.0 0.0 0.0 0.0 0.1
Investment in education (gross capital formation) 0.2 0.2 0.1 0.1 0.1
Other 0.4 0.6 0.3 0.2 0.6
   Education reform (training) 0.0 0.0 0.0 0.0 0.1
   Wages (extraordinary increases and new positions) 0.1 0.1 0.1 0.1 0.2
      Education 0.1 0.1 0.1 0.1 0.2
      Civil service 0.0 0.0 0.1 0.0 0.0
   Capitalization 0.2 0.3 0.1 0.0 0.0
      Studies 0.1 0.3 0.0 0.0 0.0
   Goods and services 0.1 0.1 0.1 0.1 0.2
      Education 0.1 0.0 0.1 0.1 0.1
      PIDI 0.0 0.0 0.0 0.1 0.1
   Foregone interest payments on capitalized enterprises 0.0 0.1 0.0 0.0 0.0
      Domestic 0.0 0.0 0.0 0.0 0.0
      Abroad 0.0 0.1 0.0 0.0 0.0
   Sectoral reforms 0.0 0.0 0.0 0.0 0.1

Sources: Ministry of Finance; and Fund staff estimates.

Table 2. Bolivia: Fiscal Indicators
(In percent of GDP)
  1997    Program Preliminary Program Revised

Nonpension balance -0.8    -0.1 -0.1 0.3 0.3
   Revenues 23.7    23.6 25 24.3 24.7

      Of which:

         Current 21.3    21.1 23 22.3 22.7
   Expenditure 24.5    23.6 25 24 24.4
         Current 17.3    16.6 18.7 17.2 17.9
         Capital 7.2    7 6.3 6.8 6.5
Pension costs (net) 2.5    4 4 3.9 4.2
Overall deficit 3.3    4.1 4 3.6 3.9
   Net external financing 2.7    3.6 2.8 2.8 2.9
   Net domestic financing                    0.5    0.6 1.2 0.8 1

Sources: Ministry of Finance; and Fund staff estimates.


Table 3. Bolivia: Limits on the Deficit of the Combined Public Sector1
and Domestic Financing of the Combined Public Sector2

(Cumulative amounts in millions of bolivianos from January 1, 1999)
Date Limits

I.  Cumulative Deficit of the Combined Public Sector3
March 31, 1999 -338
June 30, 1999 -754
September 30, 1999 -1,075
December 31, 1999 -2,066
II. Cumulative Domestic Financing of the Combined Public Sector4
March 31, 1999 91
June 30, 1999 43
September 30, 1999 49
December 31, 1999 547

1The combined deficit is the sum of domestic and external financing of the nonfinancial public sector, and the cash operating results of the central bank. The nonfinancial public sector comprises the central administration, public sector social security institutions, the local governments, other decentralized agencies, and the public enterprises.
2 Defined as the sum of: (i) the increase in the net claims of the domestic financial system and the nonfinancial private sector on the nonfinancial public sector; (ii) the net increase in floating debt and fiscal certificates; less (iii) the cash operating profits of the central bank.
3 These limits will be adjusted downward by the full amount of: (i) net proceeds from the sale of assets in excess of Bs 265 million during 1999; and (ii) the difference between programmed cumulative cash outlays for severance payments to workers of public enterprises of Bs11 million (March 31, 1999), Bs 67 million (June 30, 1999), Bs 70 million (September 30, 1999), and Bs 70 million (December 31, 1999) and actual cash outlays to workers of public enterprises excluding those related to the privatization of YPFB . These limits will be also adjusted downward (upward) by the excess (deficiency) of actual interest relief from HIPC over projected interest relief.
4 These limits will be adjusted downward by the full amount of: (i) any overdue obligations to foreign official creditors; and (ii) the difference between the programmed cumulative cash outlays for severance payments listed in footnote 3 above and actual cash outlays. In addition, these limits will be adjusted upward by the full amount of the difference between projected cumulative external financing to the nonfinancial public sector and actual cumulative external financing with a maximum upward adjustment of Bs 160 million.

Table 4. Bolivia: Limits on the Changes in Net Domestic
Assets of the Central Bank of Bolivia1,2,3

(Cumulative amounts in millions of bolivianos from January 1, 1999)
Time Period Limits

March 31, 1999 206
June 30, 1999 274
September 30, 1999 213
December 31, 1999 605

1Defined as the difference between changes in currency issue and changes in net international reserves of the central bank.
2The net international reserve flows will be measured by the difference in stocks.
3These targets will be adjusted upward by the full amount of: (i) any overdue obligations to foreign official creditors; and (ii) net proceeds from the sale of assets in excess of the amount indicated in footnote 3 of Table 2.

Table 5. Bolivia: Minimum Gain of Net International Reserves
of the Central Bank of Bolivia1,2,3
(Cumulative amounts in millions of U.S. dollars from January 1, 1999)
Date Targets

March 31, 1999 -90
June 30, 1999 -60
September 30, 1999 -50
December 31, 1999 -50

1Defined as central bank foreign assets, less all liabilities to nonresidents with an original maturity of up to and including one year plus outstanding purchases and disbursements from the Fund (excluding disbursements from the Trust Fund), net liabilities to the Latin American Reserve Fund and any other balance of payments loans, including bridging loans and those obtained by pledging the gold of the central bank.
2The net international reserve flows will be measured by the difference in stocks.
3These targets will be adjusted upward by the full amount of: (i) any overdue obligations to foreign official creditors; and (ii) net proceeds from the sale of assets in excess of the amount indicated in footnote 3 of Table 2.

Table 6. Bolivia: Limits on the Increase of Public
and Publicly Guaranteed External Debt

(Cumulative amounts in millions of U.S. dollars from January 1, 1999)
    Maturities of
  More than
Date Short Term1 One Year2

March 31, 1999 10 10
June 30, 1999 10 10
September 30, 1999 10 10
December 31, 1999   0   0

1Excludes normal import credits.
2 Excludes: (i) concessional loans with a grant element of 35 percent or more using the most recent OECD commercial interest reference rates (CIRRs); (ii) changes in central bank liabilities defined in Table 4 as part of the net international reserves; and (iii) debt renegotiation with official creditors. Includes total outstanding external debt of: (i) the nonfinancial public sector as defined in footnote 1 of Table 2; (ii) the central bank; and (iii) the private sector with official guarantee.

Table 7. Bolivia: Benchmarks and Performance Criteria for the Implementation of
Selected Structural Policy Measures

Policy Measures     Timetable for

Public sector

-- Develop plan for further strengthening of fiscal decentralization based on Fiscal Affairs Department recommendations. Oct. 1998 To be developed in 1999.
-- Offer the national smelting company Vinto for sale. Oct. 1998 A new auction is expected in May 1999.
-- Publish bid for privatization of refineries of YPFB. Feb. 1999 April 1999.
-- Design a master plan for the national road system. Dec. 1998 April 1999.
-- Transfer 70 percent of toll revenues (on existing national roads) to the SNC. Jan. 1999 Implemented. A supreme decree transferring toll revenues was passed in August 31, 1998.
-- Complete an evaluation of the costs of maintaining the road system. Mar. 1999 April 1999.
-- Develop plan for domestic tax administration reform, based on the recommendations from a coming Fiscal Affairs Department technical assistance mission. Mar. 1999 June 1999.
-- Complete privatization of the natural gas network, jet fuel stations, and natural gas bottling plants. Mar. 1999 August 1999.
-- Prepare a plan of action to reduce excess employment in the residual YPFB (including headquarters). June 1999
-- Submit to congress draft amendments to the tax code that will strengthen the tax authorities' ability to enforce tax laws. June 1999
-- Privatize refineries of YPFB. June 1999 August 1999.

Financial sector
-- Submit to congress a draft law to establish a deposit insurance system and to strengthen the resolution mechanisms for problem financial institutions. June 1999 A draft law was presented to congress on October 23, 1998.

Customs reform
-- Begin the implementation of the short-term action plan to improve customs administration. Sept. 1998    Implemented.
-- Passage of new customs law and required regulations. June 1999 July 1999.
-- Develop a plan and secure financial resources for a new information system. June 1999 July 1999.
-- Implement a new strategy of control including the creation of a unit to perform ex-post verification. June 1999 September 1999.
-- Implement new customs information system fully. Dec. 2000
-- Complete all planned infrastructure projects. Dec. 2000

Judicial reform
-- Submit to congress a draft law on administrative procedures. Sept. 1999 December 1999.
-- Submit to congress revisions to the penal and civil code procedures. End-1999
-- Submit to congress revisions to the commercial code. End-2000

Labor modernization
-- Prepare draft proposal to serve as basis for discussions. End-1998 Implemented.
-- Submit new draft labor legislation to congress. End-1999