October 6, 1999

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

Dear Mr. Camdessus,

In our Letter of Intent (LOI) and Supplementary Memorandum of Economic and Financial Policies (MEFP) dated September 15, 1999, we reiterated our commitment to implement the macroeconomic policies and structural reforms supported by the third annual ESAF arrangement.

We are pleased to report to you at this time that all the prior actions for the Board meeting, and all but one of the structural benchmarks established for end-September 1999, have been observed. With regard to the structural benchmark on the social safety net, which calls for adopting a resolution on pension system reform and approving a three-year strategic plan for the health sector, the Cabinet is scheduled to take a final decision on October 7, 1999.

Despite the progress achieved in implementing the program measures, we have encountered difficulties in adhering to some policy commitments under the program. As you know, the second tranche of the SAC III loan ($23½ million) was disbursed on September 21, 1999. This long-awaited disbursement came at a critical time. However, its conversion into drams, to assist in our effort to clear budgetary arrears, created monetary management problems and disrupted the smooth functioning of the foreign exchange market. In particular, in the last 9 days of September, reserve money exceeded the upper bound of the corridor by an average of 5 percent despite active reverse repurchase operations, and the nominal exchange rate of the dram appreciated 4 percent vis-à-vis the U.S. dollar. Our efforts to sterilize this inflow will continue; we expect to bring reserve money back to the path envisaged in the program during the first half of October.

The problems have also extended to the securities market. As reported by the staff, in all auctions conducted from August 17 through September 28, we accepted bids consistent with our announced borrowing requirements at the market clearing price, as called for in the program. However, during the auction conducted on September 30, 1999, the bids were very unevenly distributed. If we had accepted bids for the full amount of treasury bills announced, the unaccepted bidder would have been paid 15 percentage points more than the marginal interest rate of 50 percent. We understand this action contradicts our commitment in paragraph 17 of the MEFP. However, we believe that there was an unfair market practice and are conducting an investigation into the factors behind the wide dispersion of bids. In the meantime, we reiterate our commitment to accept all bids up to the total amount of bills offered at a market clearing price, thus allowing interest rates to be fully determined by market forces.

We have also experienced difficulties in eliminating all budgetary expenditure and pension benefit arrears by end-September, as envisaged in the program. The verification of overdue claims on the budget as of June 30, 1999 revealed that the outstanding stock of budgetary arrears was dram 13½ billion, 20 percent higher than reported in the LOI and MEFP. As a result, by end-September, we have been able to issue expenditure authorizations consistent with clearing only 85 percent of the revised stock of budgetary arrears; we have cleared all core budgetary expenditure arrears, and 74 percent of noncore budgetary expenditure arrears. In addition, the budgetary execution of the State Fund for Social Insurance in the third quarter was consistent with reducing the stock of such arrears from dram 3½ billion at end-June to a preliminarily estimated dram 1 2/3 billion at end-September. We intend to clear all remaining budgetary expenditure and pension benefit arrears by end-October, 1999. Attached is a revised table setting out our performance targets for the remainder of the program.

Sincerely yours,