For more information, see Georgia and the IMF

The following item is a Letter of Intent of the government of Georgia, which describes the policies that Georgia intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Georgia, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.
 
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December 6, 2000

Dear Mr. Köhler:

Georgia is continuing to implement a comprehensive economic reform program aimed at completing the transition towards a market economy. With the support of the IMF and the World Bank, the country has maintained financial stability and economic growth since 1995. Following an exchange rate adjustment in the wake of the Russian crisis, inflation has been under control and the exchange rate stable. Georgia's accession to the World Trade Organization (WTO) in June 2000 is testament to our commitment to economic reform.

Despite these considerable achievements, Georgia faces a number of daunting economic and financial challenges. The state has not been able to consolidate its finances sufficiently, partly due to problems with corruption. Tax collection, as a share of GDP, is among the lowest in the CIS. The country is facing severe difficulties in meeting its external financial obligations and is pursuing a round of debt rescheduling at the Paris Club. The shortfall in public funds is particularly serious for the country's poor, as spending on health, education, and the social safety net remains severely constrained. In addition, the recent drought has slowed down growth and enhanced the need for external assistance.

The attached Memorandum of Economic and Financial Policies outlines our key macroeconomic objectives and policies for 2001 to 2003, which are designed to address these challenges. At the center of the program is a sizeable fiscal adjustment that will be supported by structural reforms, in particular efforts to improve public sector administration and reduce corruption. The memorandum describes our initiatives to strengthen fiscal and financial institutions. The interim Poverty Reduction and Economic Growth strategy paper, which was prepared by a number of working groups and has been discussed with international institutions and representatives of civil society, lays out our broader structural reform efforts aimed at poverty reduction and economic growth. In addition, we will begin the implementation of our strategy to combat corruption, which was published in a report prepared by the anti-corruption commission in November.

In support of our economic reform program, Georgia requests a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) in an amount equivalent to SDR 108 million (about 72 percent of quota).

I am confident that the policies and measures described in the attached memorandum are adequate to achieve the objectives of the program. The government and the National Bank of Georgia will take any other measures that may become appropriate for this purpose. In the period of the PRGF arrangement, the government of Georgia will regularly consult with the Fund concerning additional measures that may become appropriate and will provide the Fund with such information as the Fund requests in connection with the progress of Georgia in implementing the policies and reaching the objectives of the program supported by the PRGF arrangement. Moreover, after the period of the arrangement, and while Georgia has outstanding financial obligations to the Fund from loans and earlier arrangements, the government will consult with the Fund on Georgia's economic and financial policies from time to time, at the initiative of the government or at the request of the Managing Director. Georgia will conduct with the Fund the first semi-annual review of its program before May 15, 2001, as described in the attached memorandum.

Sincerely yours
 
/s/
Eduard Shevardnadze
President of Georgia

 

Attachment: Memorandum of Economic and Financial Policies

 

Mr. Horst Köhler
Managing Director International Monetary Fund
Washington, D.C.
U.S.A.

Memorandum of Economic and Financial Policies for 2001-2003

I. Introduction

1. Georgia is continuing to implement a comprehensive economic reform program aimed at completing the transition towards a market economy. With the support of the IMF and the World Bank, the country has restored price stability and economic growth since 1995. After severe output losses in the early 1990s, the economy has started to recover, with an average growth rate of 6 percent between 1995 and 1999. Following an exchange rate adjustment in the wake of the Russian crisis, inflation has been brought back down to below 10 percent per annum and the exchange rate has been stable. Substantial progress has been made in privatization, liberalization, and other structural reforms. Georgia's accession to the World Trade Organization (WTO) in June 2000 is testament to our commitment to economic reform.

2. Despite these achievements, Georgia faces a number of daunting economic and financial challenges. The state has not been able to consolidate its finances, largely due to problems with governance and corruption. Tax collection, as a share of GDP, is among the lowest in the CIS. The country is facing severe difficulties in meeting its external financial obligations and is pursuing a round of debt rescheduling at the Paris Club. The shortfall in public funds is particularly serious for the country's poor, as spending on health, education, and the social safety net remains severely constrained. The situation is exacerbated by public expenditure arrears, including in the social sector. In addition, despite progress in energy sector reform, there continue to be frequent interruptions of energy supply. The small banking sector has not yet provided sufficient financial intermediation to support sustainable growth, while dollarization remains high.

3. It is against this background that we are launching our economic program for 2001-2003, for which we are seeking support from the IMF under the poverty reduction and growth facility (PRGF). It is based on continued monetary stability and on a sizeable fiscal adjustment, in order to establish orderly internal and external payments. A comprehensive agenda of institutional and structural reforms, with a focus on improving governance, will lay the foundations for sustained economic growth and poverty reduction. The recently prepared interim poverty reduction strategy paper (I-PRSP) sets out the main elements of the wider structural program, while this memorandum focuses on those policies and reforms that are crucial for the success of a macroeconomic program that could be supported by the IMF under the PRGF.

II. Performance During 2000

4. While inflation remains under control, growth prospects for 2000 have been dimmed by the adverse impact of a severe drought. Output losses in the vital agricultural sector are substantial, offsetting a positive growth trend for the rest of the economy. Annual consumer price inflation has picked up a little in recent months, reflecting an upturn in food prices associated with the drought, though it is expected to remain below 10 percent for the year as a whole.

5. Fiscal performance deteriorated markedly in the first half of 2000, with total revenues and grants of the general government falling to14¼ percent of GDP, compared with 15¾ percent for the full year of 1999. The fiscal deficit, on a commitments basis, remained high at 5¾ percent of GDP, and public expenditure arrears continued to accumulate. In light of these difficulties, parliament approved a revised budget in early July incorporating strong fiscal adjustment measures for the remainder of the year including substantial cuts in expenditure commitments. At the same time, in response to determined efforts by the tax collection agencies, tax collections recovered sharply in the third quarter and exceeded revenues in the previous year by 12 percent. The weakest performance continues to be in excise collections, whereas profit taxes, VAT, customs taxes, and social contributions are up in real terms relative to 1999. After rapid accumulation of public expenditure arrears in the first half of 2000, arrears have stabilized since end-June.

6. Monetary policy in 2000 has underpinned low inflation and a stable exchange rate, with very little extension of net credit to the government from the National Bank of Georgia (NBG). Reserve money growth in the twelve months to October 2000 was 7¼ percent, while broad money growth was 27¾ percent, partly reflecting a two percentage points decrease in reserve requirements and a significant increase in deposits. Treasury bill yields have eased to about 10 percent. Net foreign assets of the NBG were well above expectations, partly reflecting purchases of foreign exchange by the NBG, amounting to US$52 million in the five months to October. Notwithstanding these sizeable purchases, the exchange rate has remained stable. Gross international reserves of US$122 million at the end of October amounted to about one month of imports of goods and services.

7. The balance of payments position remains precarious, with large current account imbalances, low official reserves, arrears on external debt payments, and a large hump in external debt servicing in the near future. The current account deficit excluding transfers amounted to 15 percent of GDP in 1999 and little improvement is expected in 2000, given the adverse effect of the recent drought and high oil prices. Georgia continues to experience difficulties in servicing its external debts. While remaining current on all external interest obligations, Georgia has accumulated arrears on principal payments to Turkmenistan since 1998 and to Russia since the first quarter of 2000. In an effort to resolve this problem, the government is seeking a comprehensive debt rescheduling from bilateral creditors.

III. Policies for 2001-2003

8. At the center of the economic program for 2001-2003 is a sizeable fiscal adjustment that will be supported by efforts to improve governance and reduce corruption. Improved tax collection will help reduce public expenditure arrears and free resources to fight poverty and improve the social safety net. A comprehensive rescheduling of external debt will underpin Georgia's return to full solvency. Macroeconomic policies will continue to focus on low inflation. A comprehensive set of institutional and structural reforms will be aimed at strengthening governance, by improving the transparency and effectiveness of public institutions, particularly in the fiscal and financial sphere.

A. Macroeconomic prospects

9. The implementation of the economic program for 2001-2003 will allow Georgia to achieve sustainable growth and reduce external vulnerabilities. A lower budget deficit will support an increase in domestic savings and investment, raising medium-term growth prospects. Combined with the elimination of public expenditure arrears and strengthened public finances, sustained growth averaging 5 percent per year would help reduce poverty significantly over the medium term. Fiscal adjustment will also make the external debt burden more manageable and help reduce the large current account deficit. This will allow official reserves to grow over time, with the medium-term goal of covering 3 months of imports. Foreign direct investment will be attracted by macroeconomic stability and by improvements in the investment climate, including measures to strengthen governance.

B. Fiscal policies

10. A substantial fiscal adjustment is required to bring the budget back onto a sustainable path. Our short-term fiscal objective is to reduce the commitments deficit of the general government to 2 percent of GDP in 2001 from an estimated 4½ percent of GDP in 2000. This adjustment will be achieved through a combination of improved revenue collections and reduced expenditure commitments as a percentage of GDP. The program includes floors on tax revenues and ceilings on the cash deficit and expenditure arrears, which are consistent with the 2001 budget, and are set out in Table 1.

11. Low revenue collections are primarily the result of weak administrative capacity and governance problems, including corruption, in the revenue raising agencies. A comprehensive reform package aimed at strengthening the tax and customs agencies and improving tax compliance (see Section E) should ensure a consolidation of the recent upturn in tax collections through 2001 and beyond. Tax collections by the general government (including extrabudgetary revenue) are targeted to increase to 15 percent of GDP in 2001, from an estimated 14 percent of GDP this year. This will include revenues of lari 161 million from petroleum and cigarettes, two areas where governance problems have hindered tax collection in the past.

12. The necessary fiscal adjustment can only be achieved if higher revenues are combined with a containment of public expenditures. Total expenditure and net lending of the general government is planned at 18¾ percent of GDP, compared to 19½ percent of GDP in 2000. The adjustment in expenditures will involve a reallocation of resources among spending units, with a view to protecting social expenditures and allocating sufficient budgetary funds for the reform of revenue raising agencies.

13. The steady accumulation of expenditure arrears over the last few years has undermined the credibility of economic policies and deepened poverty. The stock of arrears on pensions and wages is estimated at 3¼ percent of GDP at the end of August 2000. The economic program for 2001 aims to begin the process of clearing arrears, particularly in the social sphere. To this effect, the budget for 2001 envisages a repayment of pensions, wages, and other social arrears (including payments to refugees) of lari 80 million (1¼ percent of GDP). The repayment will follow a publicly announced monthly schedule and will be fully budgeted. The medium-term objective is to eliminate all wage, pension and other social sector arrears within about 3 years. The Ministry of Finance will develop a strategy during 2001 to settle the existing stock of arrears to suppliers, including possibly through securitization.

14. Total budgetary financing is assumed to be 3¼ percent of GDP in 2001, around the level in 2000. This will include net external financing of 1¾ percent of GDP (reflecting disbursements from the World Bank and other donors, as well as the impact of assumed debt rescheduling by bilateral creditors), and privatization revenues of 1¼ percent of GDP (lari 80 million). There will be no net credit from the NBG. In the event that programmed external financing is delayed, a program adjuster will allow additional short-term credit from the NBG, up to a limit, to finance external payments on a timely basis. Such credit will be repaid when the external financing is disbursed. Privatization proceeds will be used to repay debts to the National Bank of Georgia, which will subsequently issue new credit to the government for the purpose of repaying budgetary arrears, according to the agreed schedule. Any excess in privatization proceeds will be used for additional repayment of debt to the NBG and additional reduction of budgetary arrears, in consultation with IMF staff.

C. Monetary and exchange rate policies

15. Monetary policy will be aimed at maintaining price stability over the medium term. A prudent monetary program will be maintained, with the aim to increase international reserves and keep annual inflation in the range 4-6 percent. Significant deviations from this range would signal a need to adjust monetary policy, in consultation with IMF staff.

16. The monetary program for 2001 will be consistent with projected GDP growth and our inflation target, as well as continued financial development. The program assumes a moderate decline in velocity and an increase in the money multiplier. The ceilings on net credit to the general government and on net domestic assets of the NBG (Table 1) are consistent with our fiscal program for 2001. Adjustments to these targets will be made if balance of payments support, debt rescheduling, and privatization proceeds deviate from expectations.

17. The floating exchange rate regime, adopted in the aftermath of the Russian crisis, will be maintained. The NBG will not intervene to defend the exchange rate, but will purchase foreign exchange to augment its reserves, in line with program targets for reserves accumulation (Table 1). Gross international reserves of the NBG are targeted to reach at least 1½ months of imports of goods and services by end-2001, up from a projected 1¼ months at the end of 2000.

D. External policies

18. Georgia's balance of payments and external debt position remain very difficult. With a limited capacity to service external debt obligations, arrears continue to accumulate on principal payments to Turkmenistan, and new arrears have arisen in 2000 on principal obligations to Russia. To resolve the external debt servicing problems and obtain adequate financing for an economic program that could be supported by an IMF arrangement, Georgia will seek debt rescheduling from bilateral creditors. As a first step, prior to Board consideration of the program, the government will inform bilateral creditors about the progress it has made in securing Fund support for an economic adjustment program that would form the basis for debt restructuring, and seek their agreement to participate in rescheduling discussions.

19. In light of the difficulties encountered with the previous round of debt rescheduling in 1995-97, which was conducted on a bilateral basis with little attention being paid to uniformity in treatment of creditors, Georgia will seek to carry out the proposed rescheduling in a multilateral framework, preferably under the aegis of the Paris Club. In the event that some creditors are not willing to participate in a Paris Club round, Georgia will seek to negotiate debt rescheduling with those creditors on a bilateral basis, on terms comparable to any Paris Club agreement.

20. In order to contain the accumulation of external debt and alleviate the debt service burden over the next few years, the central government, the local authorities, and the NBG will neither contract nor guarantee any new non-concessional external debt commitments during the period of the arrangement. Moreover, the Georgian government and NBG will not accumulate any new external arrears.

21. Georgia will continue to maintain its liberal trade and payments system and will adhere to the commitments made to the WTO in further liberalizing the trade and investment regime. Tariff rates are relatively low by international standards. Most import, export, and exchange restrictions, the state orders system, and capital controls have been eliminated.

E. Institutional and structural reforms

22. At the center of the economic program for 2001-2003 is a comprehensive strategy aimed at improving the transparency and effectiveness of fiscal and financial institutions in Georgia. The weaknesses in tax collection, the accumulation of expenditure arrears, and the fragility of the financial sector require a bold effort to improve governance and reduce corruption. Such institutional reforms are not only critical for macroeconomic stability and sustained growth, but will also directly improve living conditions for the socially most vulnerable and are therefore at the heart of our poverty reduction strategy. In particular, the reforms will enable the state to meet its current social obligations, while also enhancing its capacity to strengthen the social safety net over the medium term.

23. The strategy to strengthen governance includes measures to enhance the capacity of fiscal institutions for raising tax collection and controlling expenditures. It also includes the implementation of a medium-term anti-corruption strategy and safeguards against misuse of multilateral resources. Another set of measures is aimed at strengthening the financial sector institutions, by improving central bank supervision and the capacity to liquidate insolvent banks. Continued reform of the energy sector is aimed at enhancing transparency in the sector and improving its financial viability.

Reform of fiscal institutions

24. The fiscal adjustment required to bring public finances back on a sustainable path can only be achieved if it is supported by strong structural improvements in the fiscal area, on both the revenue and expenditure side. Institutional reform has already begun at the state tax department (STD) headquarters, through downsizing, salary increases, and computerization. The reform program, with support from USAID, will be completed by mid-2001. The program includes further reforms to increase tax collections, particularly in the large taxpayer inspectorate (LTI) and the state customs department. The accumulation of expenditure arrears will be contained by implementing a realistic budget supported by a new budget system law, and through better expenditure management and control. This comprehensive package of fiscal measures will contribute significantly to improving governance and reducing corruption in Georgia.

25. In order to strengthen the collection, enforcement, and audit performance in the LTI, the following actions will be taken in line with IMF technical assistance recommendations:

    a. eliminating the social funds department within the LTI and integrating its activities within the functional areas of the LTI by January 1, 2001;

    b. improving the selection process for identification of large taxpayers by April 1, 2001;

    c. implementing a system that properly controls filing and payment obligations by April 1, 2001;

    d. implementing an audit strategy applying standard audit practices by July 1, 2001; and

    e. implementing a strategy for recovering overdue taxes by October 1, 2001.

26. In order to strengthen customs collections, a reform strategy for the state customs department (SCD) developed with IMF technical assistance will be implemented in 2001. Prior to Board discussion of the program a two-year action plan will be adopted by presidential decree and a reform committee will be appointed. In addition, the following specific measures will be taken:

    a. a code of conduct for tax and customs officials will be adopted by April 1, 2001;

    b. a unit in the Ministry of Revenues responsible for monitoring and controlling exemptions will be established by April 1, 2001;

    c. the procedures for granting exemptions, supported by amendments to legislation and regulations, will be improved by July 1, 2001; and

    d. the processing and control of transit cargo will be strengthened by October 1, 2001.

27. In order to pay VAT refunds in a timely manner, while protecting the revenue collections from fraudulent claims, a simplified VAT refund system will be put in place (efforts in this regard will be assisted by the recent increase in the exempt turnover threshold to lari 24,000). This will involve, by April 1, 2001:

    a. a requirement to carry forward unused credits for up to 6 months and offset them against VAT payments, with the only exception being for exporters and large investors;

    b. rules for distinguishing claimants according to their compliance record; and

    c. the Ministry of Revenues setting up a system to monitor refunds claimed and refunds paid, and reporting these on a regular basis.

28. To improve revenue collections and reduce distortions in the economy, tax policy will aim to broaden and simplify the tax system. Measures to be implemented with the 2001 budget include:

    a. revenue-raising measures, including possible changes to excise rates;

    b. a simplification and modest increase in the progressivity of the personal income tax;

    c. no new tax exemptions, unless required by an international treaty ratified by parliament; and

    d. no extension of existing tax incentives granted under the law on foreign investment.

29. The commission on tax policy reform established in August 2000, is preparing a comprehensive medium-term reform plan, in close consultation with the fiscal affairs and legal departments of the IMF, and will present it to parliament early in 2001. Over the medium term, the government, including the active participation of the ministry of finance, will seek to ensure that a significant share of revenues from oil and gas pipelines accrue to the budget.

30. To reduce the amount of tax arrears, the government will review ways to facilitate the seizure of financial assets from nonpayers on an administrative basis, subject to rules that ensure equal treatment and transparency of the process. The government will also review the possibility of establishing rules for repaying tax arrears in installments. The government will refrain from applying tax amnesty and from conducting offset transactions.

31. To reverse the accumulation of expenditure arrears, a realistic budget is essential. In addition, it is paramount to introduce a proper commitments control and accounting system. To this end, by July 1, 2001:

    a. an audit of expenditure arrears will be undertaken, involving the verification of all unpaid bills by line ministries, which will help prevent fraudulent claims from suppliers when an arrears repayment program is initiated; and

    b. the treasury will introduce a system of commitments recording in respect of (i) purchase orders of goods, services and contract above lari 5,000; and (ii) wages, pensions, debt service payments and other transfers.

These steps will be facilitated by the early appointment of a new resident FAD treasury advisor.

32. To further strengthen expenditure control and management, all central treasury functions will be fully consolidated in the Ministry of Finance. This will require:

    a. transferring the sub-treasury accounts in the ministries of defense and interior to the Ministry of Finance, prior to IMF Board consideration of the program;

    b. reflecting all off-budget accounts in the 2001 budget law to be approved by parliament prior to IMF Board consideration of the program; and

    c. applying standard expenditure control procedures to expenditures from these accounts from January 1, 2002.

33. An improved expenditure control framework will be fully implemented to facilitate the execution of the 2001 budget. This will include the following components from January 1, 2001:

    a. the preparation of monthly cash inflow forecasts jointly by the Ministry of Finance and the National Bank of Georgia;

    b. the preparation by the Ministry of Finance of projected cash availability on a weekly basis;

    c. the issuance by the budget department of quarterly guidelines on a rolling basis with monthly distribution by spending units and major economic categories; and

    d. based on this information, the issuance by the treasury of four different cash limits for prioritized categories of expenditure items.

34. The Ministry of Finance will refrain from issuing loan guarantees within the domestic banking system or any similar type of commitment.

Reform of financial institutions

35. Further reforms in the financial sector will involve efforts to strengthen the banking system, broaden the opportunities for investment, and develop the capital markets. Taken together, these institutional reforms will significantly contribute to strengthening transparency in the financial sector, reducing systemic risks, and mobilizing domestic savings.

36. The NBG will implement the following measures to strengthen the banking system:

    a. raise the minimum capital requirements of existing banks to lari 5 million by January 1, 2001;

    b. improve the legal and regulatory framework for bank supervision and resolution, including by issuance of new asset classification regulations for commercial banks (December 2000); issuance of conflict of interest regulations for banks (March 2001); and amending legislation so as to establish the primacy of banking law in bank-related matters (by June 2001); and

    c. implement international accounting standards in commercial banks comprising 80 percent of total banking sector assets by September 2001.

37. In addition, during 2001, the NBG will vigorously enforce prudential requirements in line with the supervisory action framework, including by revoking licenses of banks that fail to meet the requirements. The NBG will also continue to adapt its regulations to changes in the financial sector and strengthen the skills of banking supervision staff through training. The NBG will also seek to make regulations more transparent and easily understood by commercial banks.

38. Over the medium term, the authorities will foster financial development by facilitating the entry of foreign banks to promote competition; reducing interest rates by limiting government borrowing and repaying debt; improving banks' ability to assess risk, including providing access to training; and removing legal obstacles to using collateral (including land) for lending. Capital market growth will be enhanced by the development of the secondary treasury bill market, including through the securitization of government debt to the NBG. This will broaden the treasury bill market to non-banks and allow the NBG to utilize open market operations more effectively. The Ministry of Finance will also aim to steadily increase the maturity of treasury bills. We will also encourage the development of the nascent Georgian Stock Exchange (GSE) and strengthen the newly established and independent National Securities Commission.

39. The NBG will continue to enhance transparency and will comply with IMF standards for safeguarding the IMF's financial resources. To this end, as in previous years the NBG will publish an audit, undertaken by an international accounting firm, of its full financial statements for 2000 by June 30, 2001. It will continue to take a cautious approach to profit distribution, and in particular will not distribute profits associated with revaluation gains.

Energy sector reform

40. Georgia's dependence on imported energy and its strategic location for energy transportation imply that the sector is highly relevant for macroeconomic stability and growth. It is critical that the accumulated debt of the electricity sector, estimated at over US$500 million at September 1, 2000 (excluding government debt to donors), is resolved without transferring it to the central government. The lack of a reliable energy supply places additional costs on businesses and undue hardship on the population, especially on the socially vulnerable.

41. We have therefore given high priority to the restructuring of the energy sector, supported by multilateral and bilateral partners, including the World Bank. Georgia is committed to cooperating with the World Bank and others to restore the sector's financial viability and economic efficiency over the medium run. The highest priority measure is the enhancement of private sector participation in the distribution and transmission of electricity as well as the management of the wholesale electricity market, to eliminate nonpayments and prevent the further accumulation of debt.

42. As part of these wider reform efforts in the energy sector, an approach to restructuring the existing energy debt has been agreed with the World Bank. Audits of the energy debts have already been carried out by international auditors (funded by USAID) and the Georgian government agencies (including the Energy Debt Commission and the Chamber of Control). The government recognizes that the time for action has now arrived. The economic program for 2001 therefore includes the following short-term measures to address the risks from the high debts and arrears of the energy sector, as well as to increase transparency and reduce corruption:

    a. submission to parliament of amendments to the Energy Law to allow a debt surcharge on the electricity tariff, prior to Board consideration of the program;

    b. the Energy Debt Commission will outline its preferred debt restructuring terms, and negotiations will commence on this basis with creditors by March 31, 2001; and

    c. introduction of a debt surcharge on the electricity tariff beginning on June 1, 2001 (at an initial level of 0.3-0.7 tetri/kWh). The proceeds of the surcharge will be put in an escrow account to be used exclusively for debt service payments, to be managed by the Wholesale Electricity Market Administration as settlement agent. Biannual adjustments in the debt surcharge will be made subsequently depending on the outcome of debt restructuring negotiations.

Anti-corruption strategy

43. Combating corruption requires a multi-pronged strategy. The measures aimed at strengthening fiscal and financial institutions described above are a key component of the strategy to address the wider governance problem in Georgia. In addition, we have recently taken a number of specific steps to address the problem of corruption, including:

    a. establishment of a presidential anti-corruption commission that has prepared a comprehensive medium-term anti-corruption strategy; and

    b. the examination of tax administration officials to test their competence, resulting in a significant number of dismissals (about two-thirds of those tested).

44. The medium-term strategy we have developed is broad based and will address corruption through actions in the following main areas:

    a. liberalization of the business environment (including transparency in licensing, simplicity of tax rules, improvements in registration and certification procedure);

    b. strengthening of public finances (including improving transparency in the budgetary and procurement systems, internal audit procedures, management of state assets and liabilities);

    c. strengthening the civil service (including ethical codes, financial disclosure, conflicts of interest rules, and adequate incentives for employees); and

    d. strengthening law enforcement and the judiciary (including streamlining functions, ethical codes).

45. The anti-corruption strategy paper and the list of short-term anti-corruption measures of the government, endorsed by the president, has been published.

46. Progress in tackling corruption will be monitored by an Anti-Corruption Coordination Council under the president with NGO's and civil society representatives. With a new IMF-supported program, it would also be monitored indirectly through program revenue targets for excisable goods, as well as through meeting our commitments on the reform of fiscal and financial institutions. A program review in mid-2001 will assess progress in implementing the near-term measures identified in the anti-corruption strategy paper.

Poverty reduction strategy

47. We have prepared an I-PRSP, with support from the World Bank, the IMF, and other donors. This paper reflects the work of several working groups (social sector, fiscal and monetary policy, agriculture and environmental protection, infrastructure, and management and state administration reform), which have been established to develop policies to tackle poverty.

48. The World Bank will play an integral role in supporting our poverty reduction strategy. SAC III includes measures to strengthen fiscal performance, ensure budgetary provisions for core social expenditures, improve the legal and regulatory framework for the private sector, privatization, and market liberalization. Reform of secondary education is also being assisted by the World Bank. The Energy Sector Adjustment Credit (ESAC) supports efforts to enhance financial sustainability of the energy sector. In the first half of 2001, the World Bank will prepare a public expenditure review. A fourth SAC is expected in 2001 and will provide wide-ranging reform measures in public sector governance, agriculture, energy, and privatization.

49. The IMF will also play a vital role in this process, by advising on macroeconomic policy and on key institutional reforms in the fiscal and financial areas. An IMF-supported program under the PRGF will be critical for maintaining macroeconomic stability, improving prospects for sustainable growth, and improving governance. Apart from the indirect impact of sustainable growth on poverty reduction, the program will, through its marked improvement in public finances, address poverty directly by reducing public expenditure arrears in the social sphere and freeing public resources for social sector programs.

IV. Program monitoring

50. Our commitment to move towards a sustainable fiscal policy and strengthen governance will be underscored by a number of measures that are to be implemented prior to the consideration of the program for 2001-2003 by the IMF Board of Executive Directors (Annex A).

51. The new PRGF arrangement will involve quarterly monitoring and disbursements, as well as semi-annual reviews. The first review will be completed before May 15, 2001 and will focus on an assessment of progress in implementing the near-term anti-corruption measures. The second review, to be completed before November 15, 2001, will focus on progress in strengthening the banking sector and energy debt restructuring.

52. The proposed IMF-supported program under the PRGF will include fiscal, monetary, and external performance criteria. The quantitative performance criteria and indicative targets through the end of 2001 are specified in Table 1. Technical definitions, adjustment mechanisms, and reporting requirements are provided in the supplementary Technical Memorandum of Understanding (TMU).

    a. In the fiscal area, the quantitative performance criteria will be ceilings on the cash deficit of the general government and on expenditure arrears, and floors on total tax revenues.

    b. In the monetary sphere, the quantitative performance criteria will be a ceiling on net domestic assets of the NBG, a ceiling on net credit of the banking system to the general government, and a floor on net international reserves of the NBG.

    c. Regarding external debt, there will be ceilings on contracting and guaranteeing new non-concessional external debt by the public sector.

53. The proposed IMF-supported program also includes continuous performance criteria. During the period of the arrangement, the general government and the NBG will not accumulate any new external payment arrears; will not impose or intensify restrictions on payments and transfers for current international transactions; will not introduce multiple currency practices; will not conclude bilateral payments agreements that are inconsistent with Article VIII; and will not impose or intensify import restrictions for balance of payments purposes.

54. The proposed IMF-supported program also includes structural benchmarks (Annex B), with an emphasis on strengthening governance by improving fiscal and financial institutions. Further structural reforms aimed at poverty reduction are laid out in the I-PRSP and will be implemented with assistance from the World Bank and other multilateral and bilateral partners.

Annex A: Actions Prior to IMF Board Consideration

In line with the above discussion, the following actions will be taken prior to the consideration of the program for 2001-2003 by the IMF's Board of Executive Directors:

    1. Satisfactory macroeconomic performance relative to agreed quantitative targets through end-November (excluding expenditure arrears for November, data for which will not be available until early January 2001);

    2. Adoption and passage by parliament of a 2001 budget fully consistent with the economic program described in this memorandum, including associated revisions to the tax code;

    3. Securing appropriate financing assurances from external creditors;

    4. Elimination of the sub-treasury accounts in the ministries of defense and interior and transfer of their functions to the central treasury at the Ministry of Finance;

    5. Recording of off-budget accounts of line ministries in the 2001 budget law.

    6. Publication of the anti-corruption strategy paper, including a list of short-term anti-corruption measures, endorsed by the president.

    7. Submission to parliament of amendments to the Energy Law to allow a debt surcharge on the electricity tariff.

    8. Issuance of a presidential decree adopting a two-year action plan for Customs reform and appointing a reform committee.

Annex B: Structural Benchmarks

 

Deadline

 

A. Fiscal measures

   
     

1. Adoption of a code of conduct for tax and customs officials.

April 1, 2001

 

2. Amend legislation and regulations to strengthen control on procedures for granting customs exemptions.

July 1, 2001

 

3. Implement simplified VAT refund system and monitor refunds claimed and paid.

April 1, 2001

 

4. Audit the stock of expenditure arrears.

July 1, 2001

 

5. Introduce commitments recording and strengthen commitments control.

July 1, 2001

 

6. Apply standard expenditure control procedures to off-budget accounts outside the treasury.

January 1, 2002

 
     

B. Financial sector

   
     

7. Amend legislation to establish primacy of banking law in bank-related matters.

June 30 2001

 

8. Issue new asset classification regulations for commercial banks.

Dec. 31, 2000

 

9. Issue conflict of interest regulations for banks.

March 31, 2001

 

10. Implement IAS in commercial banks comprising 80 percent of total banking sector assets.

Sept. 30, 2001

 
     

C. Energy sector

   
     

11. Impose debt surcharge of 0.3-0.7 tetri/kWh on the electricity tariff.

June 1, 2001

 

INTERNATIONAL MONETARY FUND

GEORGIA

Technical Memorandum of Understanding (TMU)

December 6, 2000

1. This memorandum sets out the understandings between the Georgian authorities and the IMF staff regarding the definitions of quantitative performance criteria and indicative targets for the arrangement supported under the Poverty Reduction and Growth Facility (PRGF) reported in Table 1 of the associated Memorandum of Economic Financial Policies (MEFP), as well as respective reporting requirements. It also provides definitions and reporting requirements for the continuous performance criteria described in paragraph 53 of the MEFP.

2. The quantitative performance criteria (ceilings and floors) and indicative targets listed in Table 1, Sections 1 and 2, of the MEFP are defined as cumulative changes from end-September 2000. Some floors and ceilings are adjusted by cumulative deviations of certain external financing flows from projections (Table 1, Section 3, of the MEFP), converted at an accounting exchange rate of lari 2 per U.S. dollar.1 The program relies on adjusters that are symmetric and allow the substitution of net external non-project financing for net domestic credit to government (and net domestic assets of the NBG). However, any resulting increases in net domestic credit to government and net domestic assets of the NBG are subject to a cap. The program also allows for an automatic adjustment to the cash deficit target in case of deviations of external project financing from expectations, subject to a cap on upward adjustment.

3. While the adjustment mechanism is designed to accommodate unanticipated, temporary fluctuations in external financing, the caps imply that significant shortfalls in financing will require policy changes, including tighter fiscal policy, which would need to be considered in the context of a program review.

Quantitative Performance Criteria, Indicative Targets, and Continuous Performance Criteria: Definitions and Reporting Standards

A. Floor on Tax Revenues

4. Definition: Tax revenues are defined as total tax collections by the State Tax Department and the State Customs Department, including tax revenues from the central government, local governments, and extrabudgetary funds. The tax revenues are recorded when these are paid into the treasury's revenue account(s) in the National Bank of Georgia (NBG). The tax revenues exclude the amounts retained by the revenue agencies for bonus payments.

5. Adjustment clauses: Once a change is made in accounting practices so that the bonus payments to the revenue agencies are included in the treasury's revenue account(s), the revenue targets will be adjusted upward by the applicable bonus share.

6. Supporting material: The Ministry of Finance (treasury) will provide data showing a detailed breakdown of tax revenues paid into the NBG revenue accounts (form 412) on a monthly basis within two weeks of the end of each month. The local budget department in the Ministry of Finance will provide additional information on revenue collections of local governments. The authorities will also provide data on any offset transactions on a monthly basis.

B. Indicative Target for Revenues from Cigarettes and Petroleum

7. Definition: This is defined as the total of customs duties, excise duties, and VAT collected by the State Tax Department and the State Customs Department on the domestic production and imports of cigarettes and petroleum products.

8. Adjustment clauses: None.

9. Supporting material: The Ministry of Finance will provide data with a break-down into the main categories of products on a monthly basis within two weeks of the end of each month.

C. Ceiling on Expenditure Arrears

10. Definition: Expenditure arrears are defined as a subset of arrears incurred by the general government on the following expenditure items: wages, pensions, assistance to refugees and internally displaced persons, healthcare state programs, invalid assistance state programs, and scholarships. Once sufficient progress is made on introducing commitments recording in the treasury, the measurement of arrears will be strengthened by applying the following principles for recording expenditure arrears: (a) the goods and services have been received; (b) these have been certified to conform to the order of the contract; (c) the bill for payment has been received; and (d) the bill has remained unpaid beyond the normal or agreed period of credit. Until then, the net change in arrears will be estimated as the difference between actual cash spending and the monthly cash limits issued to spending units prior to the beginning of the month.

11. Adjustment clauses: None.

12. Supporting material: The Ministry of Finance (treasury) will provide monthly data, with a detailed break-down by economic and organizational category, on cash spending and commitments made by the central government, and/or cash limits issued to the spending units. The information on cash limits and spending commitments will be provided within two weeks from the beginning of each month. The information on cash spending will be provided within four weeks of the end of each month. The local budget department in the Ministry of Finance will provide information on monthly spending by the local budgets, and the extrabudgetary funds will provide information, through the Ministry of Finance, on their monthly expenditures.

D. Ceiling on the Cash Deficit of the General Government

13. Definition: The cash deficit of the general government will be measured from "below-the-line", equal to the total financing (domestic and external, plus privatization proceeds) received by the general government.2 Privatization receipts consist of all gross proceeds received by the central and local governments. Domestic financing consists of all bank and non-bank financing to the general government. External financing is defined as the total of disbursements, macroeconomic support, net change in arrears, minus amortization. This include all project financing (capital expenditure and net lending) and balance of payments support (excluding grants) received by the budget.

14. Adjustment clauses: The ceiling will be adjusted to reflect cumulative deviations from program assumptions about external project financing for capital expenditure or net lending (see Table 1, Section 3, of the MEFP). The ceiling at the end of a quarter will be adjusted upward (downward) by the full amount of the cumulative excess (shortfall) of external project financing. There will be a cap on cumulative upward adjustment of lari 80 million.

15. Supporting material: Data on privatization receipts will be provided by the Ministry of Finance (treasury) on a monthly basis within two weeks of the end of each month. The data will be consistent with the revenue account(s) in the NBG (form 412). Data on domestic financing (bank and non-bank) will be provided by the NBG. Until further improvements in the NBG accounts, the treasury will provide information on Ministry of Finance guaranteed loans (including guaranteed amount, principal repayment schedule, and actual principal and interest payments). Data on external project financing will be provided by the Ministry of Finance in a table on project and grant disbursements by creditor, on a monthly basis within two weeks of the end of each month.

E. Ceiling on Net Credit of the Banking System to the General Government

16. Definition: Net credit of the banking system to the general government includes net credit to the general government from the NBG and the deposit money banks. General government is defined in this context as the central government, local government, and extrabudgetary funds. Credit to the government includes: all loans to the general government, all treasury bills issued by the general government (including those purchased by the central bank), as well as all government-guaranteed loans from the banking system to other entities. Net credit to the government is credit to the government less deposits of the general government in the banking system. In addition, any accrued government interest obligations to the NBG would be reflected in net credit to the government. Government bonds issued to cover NBG losses are excluded from net credit to the government.

17. Adjustment clauses: The ceiling on net credit of the banking system to the general government will be adjusted to reflect cumulative deviations from program assumptions on net external non-project financing (see Table 1, Section 3, of the MEFP), which is defined as the sum of all foreign-currency denominated privatization receipts and net disbursements under the World Bank's SAC and ESAC programs, minus government debt amortization payments. The ceiling at the end of a quarter will be adjusted upward (downward) by the full amount of the cumulative shortfall (excess) of net external non-project financing, subject to a cap on cumulative upward adjustment of lari 65 million for the end-December 2000 ceiling and lari 40 million for the end-quarter ceilings in 2001.

18. Supporting material: The NBG will provide the monetary survey on a monthly basis within two weeks of the end of each month. The NBG will also provide information on the activities of the treasury bill market. The necessary information on net external non-project financing will be provided in a table on the NBG's foreign exchange flows (which includes details on inflows, outflows, and net international reserves) on a monthly basis within a week of the end of each month. The Ministry of Finance will provide additional information on the repayment of principal and interest on government-guaranteed loans from commercial banks on a monthly basis.

F. Ceiling on Net Domestic Assets of the NBG

19. Definition: Net domestic assets of the NBG are defined as the difference between net foreign assets and reserve money. Net domestic assets include net claims on government (including loans and treasury bills purchased by the NBG, accrued government interest obligations to the NBG, less deposits of the government with the NBG.), claims on banks, claims on the rest of the economy (including the KfW loan), and other items net (including the NBG capital accounts, net unclassified assets, counterpart funds and exchange rate revaluation).

20. Adjustment clauses: The ceiling on net domestic assets of the NBG will be adjusted to reflect cumulative deviations from program assumptions on net external non-project financing (see Table 1, Section 3, of the MEFP), which is defined as the sum of all foreign-currency denominated privatization receipts and net disbursements under the World Bank's SAC and ESAC programs, minus government debt amortization payments. The ceiling at the end of a quarter will be adjusted upward (downward) by the full amount of the cumulative shortfall (excess) of net external non-project financing, subject to a cap on cumulative upward adjustment of lari 65 million for the end-December 2000 ceiling and lari 40 million for the end-quarter ceilings in 2001.

21. Supporting material: The NBG will provide data on its balance sheet, which includes data on its net domestic assets, on a monthly basis within one week of the end of each month. The necessary information on net external non-project financing will be provided in a table on the NBG's foreign exchange flows (which includes details on inflows, outflows, and net international reserves) on a monthly basis within one week of the end of each month.

G. Floor on Net International Reserves of the National Bank of Georgia (NBG)

22. Definition: Net international reserves (NIR) of the NBG in U.S. dollars are calculated on the basis of assets and liabilities of the NBG, using program assumptions of bilateral exchange rates (2 lari per U.S. dollar and 1.35 U.S. dollar per SDR). NIR of the NBG are defined as liquid, convertible currency claims of the NBG on nonresidents that are readily available. Pledged or otherwise encumbered assets, including but not limited to assets used as collateral (or guarantee for third party external liabilities) are excluded from reserve assets. Reserve liabilities include the use of Fund resources and any other liabilities of the NBG. The stock of NIR in period t is calculated as the stock of NIR in period (t-1) plus the net inflow of foreign exchange in period t, the change in the value of gold stock at market prices in period t, and the change in the stock of liabilities to the IMF and other creditors in period t.

23. Adjustment clauses: The floor of net international reserves will be adjusted to reflect cumulative deviations from program assumptions on net external non-project financing (see Table 1, Section 3, of the MEFP), which is defined as the sum of all foreign-currency denominated privatization receipts and net disbursements under the World Bank's SAC and ESAC programs, minus government debt amortization payments. For a shortfall (excess) of net external non-project financing, the floor will be adjusted downward (upward) by the full amount, subject to a cap on cumulative downward adjustment of US$32.5 million.

24. Supporting material: Data on net international reserves and data on net external non-project financing will be provided in a table on the NBG's foreign exchange flows (which includes details of inflows, outflows, and net international reserves) on a monthly basis within the week following the end of the month.

H. Ceiling on Contracting or Guaranteeing New Non-Concessional Medium- and Long-term External Debt by the Public Sector (with original maturity of 1 year or more)

25. Definition: The public sector consists of the central government, the National Bank of Georgia (NBG), and local authorities. Concessional external loans are defined as loans with a grant element of at least 35 percent of the value of the loan. The grant element is to be calculated by using currency-specific discount rates reported by the OECD (CIRRs).3 For maturities of less than 15 years, the grant element will be calculated based on six-month averages of commercial interest rates. For maturities longer than 15 years, the grant element will be calculated based on 10-year averages. The term "debt" includes all current liabilities, which are created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which require the public sector (obligor) to make one or more payments in the form of assets (including currency), at some future point(s) in time to discharge principal and/or interest liabilities incurred under the contract. In effect, all instruments that share the characteristics of debt as described above (including loans, suppliers' credits, and leases) will be subject to the ceiling. The term "debt" also applies to commitments contracted or guaranteed for which value has not been received.

26. Adjustment clauses: None.

27. Supporting material: Details of all new commitments and government guarantees for external borrowing, with detailed explanations, will be provided by the Ministry of Finance on a monthly basis within two weeks of the end of each month.

I. Ceiling on Contracting or Guaranteeing Short-Term External Debt by the Public Sector (with original maturity of 1 year or less)

28. Definition: The public sector consists of the central government, the National Bank of Georgia (NBG), and local authorities. The term "debt" includes all current liabilities, which are created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which require the public sector (obligor) to make one or more payments in the form of assets (including currency), at some future point(s) in time to discharge principal and/or interest liabilities incurred under the contract. In effect, all instruments that share the characteristics of debt as described above (including loans, suppliers' credits, and leases) will be subject to the ceiling. The term "debt" also applies to commitments contracted or guaranteed for which value has not been received.

29. Adjustment clauses: None.

30. Supporting material: Details of all new commitments and government guarantees for external borrowing, with detailed explanations to be provided by the Ministry of Finance on a monthly basis within two weeks of the end of each month.

J. Non-accumulation of External Arrears

31. Definition: During the period of the arrangement, the general government and the NBG will not accumulate any new external payment arrears. Official arrears on external debt service obligations include any non-payment of interest and/or principal in full and on time falling due to all creditors, including the Fund, the World Bank, and other official creditors. Exemptions under the continuous performance criterion on arrears, in the context of reaching an agreement on rescheduling debt to bilateral creditors with whom Georgia has undertaken a debt rescheduling in the past, will have to be agreed with the IMF.

32. Adjustment clauses: None.

33. Supporting material: Details of official arrears accumulated on interest and principal payments to creditors will be reported within one week from the date of the missed payment.

K. Non-introduction of exchange and trade restrictions

34. Definition: During the period of the arrangement the general government and the NBG will not impose or intensify restrictions on payments and transfers for current international transactions; will not introduce multiple currency practices; will not conclude bilateral payments agreements that are inconsistent with Article VIII; and will not impose or intensify import restrictions for balance of payments purposes.

35. Adjustment clauses: None.

36. Supporting material: The government and NBG will inform the Fund about any changes to the exchange and trade regime.

L. Indicative Target for Reserve Money

37. Definition: Reserve money is defined as currency in circulation and required reserves of deposit money banks and balances on banks' correspondent accounts.

38. Adjustment clauses: None.

Supporting material: The central bank balance sheet is to be transmitted on a monthly basis, within one week of the end of the month.


1 For instance, if a disbursement of $10 million originally projected to accrue in the first quarter of 2001 is delayed until the second quarter of 2001, then an adjuster of $10 million (lari 20 million) would apply to end-March 2001 targets, but not to end-June 2001, when net external financing would have returned - on a cumulative basis - to the originally projected level. In practice, this means that a delay in external financing inflows can be compensated temporarily by higher domestic credit, but not permanently, implying a repayment to the NBG once the delayed disbursement accrues.
2 Modest differences between the recorded financing and the cash deficit, calculated as expenditures plus net lending minus revenues and grants, can be attributed to check-float and smaller errors and omissions.
3 An electronic spreadsheet file that shows the relevant discount rates reported by the OECD (CIRRs) will be provided on a periodic basis by Fund staff.



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