Republic of Lithuania and the IMF

Press Release: IMF Approves US$111 Million Stand-By Arrangement for Lithuania

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

Vilnius, July 26, 2001

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

Use the free Adobe Acrobat Reader to view the Tables (133kb PDF file)

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

1.  The overarching objective of Lithuania's economic policies is to promote sustained economic growth and improved living standards through continued macroeconomic stability and further implementation of structural reforms necessary for an efficiently functioning of market economy and enhancement of competitiveness. Early accession to the EU and NATO is our main policy goal. The key elements of our economic policy strategy will be to maintain the currency board arrangement as the cornerstone of macroeconomic stability; to further fiscal consolidation in order to support external viability; and to advance the remaining key structural reforms at a fast pace. The attached Memorandum of Economic Policies (MEP) lays out the concrete policy measures to be taken during July 1, 2001-December 31, 2002.

2.  In support of the policies detailed in the MEP, we request approval of a 19-month stand-by arrangement with the International Monetary Fund (IMF), in an amount equivalent to SDR 86.52 million. We do not envisage at this time making purchases under the arrangement, but could do so if economic circumstances were to be worse than expected. We understand that the Fund will monitor the program on the basis of quarterly performance criteria, and three reviews will be conducted, as laid out in the MEP.

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

4.  We are committed to transparency in our economic policies, and we authorize the Fund to publish this letter and the MEP following Executive Board approval of the program.

Yours sincerely,

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



Memorandum of Economic Policies of the Government and
Bank of Lithuania for the Period

July 1, 2001-December 31, 2002

I. Introduction

1.   During the past eighteen months, Lithuania has made significant progress in restoring macroeconomic stability, following severe disruptions in 1998-99 in the wake of the Russian financial crisis. Decisive steps were undertaken with the support of a stand-by arrangement with the IMF, treated as precautionary, including the reduction of the general government fiscal deficit from 8.5 percent of GDP in 1999 to 2.8 percent in 2000, with a deficit of 1.4 percent of GDP planned for 2001. Exports grew by more than 25 percent in 2000, strongly outpacing the recovery of imports, so that the current account deficit declined from 11.2 percent of GDP in 1999 to 6.0 percent in 2000. Growth resumed in 2000, with real GDP increasing by 3.3 percent, as compared with a decline of 3.9 percent in 1999, and inflation remained subdued, with the average consumer price index (CPI) increasing by 1 percent on an annual basis. All of these positive developments boosted confidence in the Lithuanian economy and its currency board arrangement (CBA), allowing for continued access to international capital markets at increasingly favorable rates.

2.   Substantial progress was made during 2000 and the first half of 2001 in implementing structural reforms, essential to an efficiently functioning market economy, with the support of a Structural Adjustment Loan (SAL) from the World Bank. Particularly important steps included: an initiation of the pension reform and strengthening of the finances of the state Social Insurance Fund (SoDra); significant fiscal structural reforms, including passage of the Organic Budget Law and steps to set up a Reserve Stabilization Fund (RSF) for the investment of privatization proceeds; important reforms of the Treasury system; a strengthening of the finances of Lithuanian Power (LPC) and Lithuanian Gas (LG) in advance of their future privatization; a rationalization of agricultural subsidies and support programs; passage of new bankruptcy and company restructuring laws, as well as amendments to the labor code to render the labor market more flexible; and a major breakthrough in privatization efforts, with the sale of an additional 25 percent stake in Lithuanian Telecoms via a public offering in June 2000, and of the Savings Bank and the Lithuanian Shipping Company (LISCO) in the first half of 2001 to major foreign investors via competitive tenders. At the same time, trade was liberalized further, with the accession to the WTO ratified in April 2001, while major progress towards European Union (EU) accession was registered.

3.   In spite of this progress, some areas of weakness remain. Registered unemployment increased from 10.0 percent at end-1999 to 12.1 percent in June 2001, and social safety nets need to be reinforced. Further improvements to the business environment and greater labor market flexibility are needed, in order to promote higher rates of growth, domestic and foreign investment, output, and employment creation. In fact, investment slumped from 26.5 percent of GDP in 1997 to just over 20 percent of GDP in 2000, and credit growth was sluggish during much of 2000. Insufficient progress was made in restructuring the electricity and gas sectors, leading to delays in privatization. Expenditure arrears of the central government, which amounted to LTL 440 million at end-1999, were reduced to LTL 19 million by end-March 2001, but not fully eliminated as targeted under the previous stand-by arrangement, while municipal arrears increased. Improvements in health and education are needed, and the finances of municipalities and the Health Insurance Fund (HIF) should be strengthened.

II. The Government's Program for 2001-02

A. Objectives and Strategy

4.   The new program aims at maintaining macroeconomic stability, strengthening external viability, and accelerating second-generation structural reforms. These efforts will place Lithuania in a strong position to achieve early accession to the EU and contribute over time to higher, more sustainable growth, greater employment opportunities, higher incomes, and increased welfare for the Lithuanian population, as well as pave the way for a smooth repegging of the litas from the dollar to the euro. To achieve these goals, the government and Bank of Lithuania (BoL) intend to follow a three-pronged strategy of:

    (i) maintaining the currency board arrangement as the cornerstone of macroeconomic stability. In this context, the BoL is preparing for the switch of the anchor currency from the dollar to the euro on February 2, 2002, in response to the increasing economic integration with the EU area;

    (ii) continuing the fiscal consolidation effort, aiming to achieve a credible budget deficit reduction path, which is necessary to support the CBA and maintain external viability. Fiscal policy will also take into account the government's plans for rationalizing the tax structure, as well as the need to face a number of new expenditure obligations, fund the pension reform, stabilize municipal finances, and restructure expenditure on health and education. The target of achieving a balanced budget at the time of EU accession would contribute to assure medium-term external sustainability;

    (iii) advancing the remaining key structural reforms at a fast pace, in order to boost productivity and competitiveness, and underpin fiscal consolidation. The government is determined to promote timely passage of the necessary legislation, and aims at quickly establishing a track record of successful implementation in all areas, thus strengthening the capacity of the economy to withstand increased competition and reap the full benefits of EU accession. In this regard, efforts will focus on addressing remaining fiscal structural weaknesses; continuing financial sector reform; improving the business environment; enhancing labor market flexibility; and completing the privatization program.

B. Macroeconomic Outlook

5.   The macroeconomic outlook for 2001-02 envisages a continued recovery of growth, low inflation, and the maintenance of the external current account deficit at a sustainable level. Economic growth is projected to accelerate from about 3.6 percent in 2001 to 4.7 percent in 2002, underpinned by a recovery of domestic demand and continued good export performance. Average inflation is projected at around 1 percent in 2001 and 3 percent in 2002. The external current account deficit is projected to widen slightly to 6.7 percent of GDP in 2001, reflecting the pick-up of domestic demand from 2001, and to start to narrow again in 2002, due to sustained export growth, enhanced productivity, a more business-oriented regulatory environment and a deepening of structural reforms. Foreign direct investment is projected to increase significantly in 2001-02, as several major privatization projects are to be completed during these years. Access to capital markets on favorable terms is expected to continue, and external debt ratios would remain stable.

6.   Over the medium term, macroeconomic policies will aim at boosting real growth rates to about 5-6 percent a year, maintaining inflation at around 2-3 percent, consistent with faster productivity growth than in trading partners, and gradually reducing the external current account deficit to below 6 percent of GDP by 2005. This projected path would be underpinned by further fiscal consolidation, reaching a balanced budget position (excluding the cost of the pension reform) at the time of EU accession, assumed to occur in 2004, as well as further improvement in Lithuania's external competitiveness, brought about by structural reforms. A sizable share of EU-related investment would be financed by EU transfers, and about half of the external current account deficit would be financed by FDI inflows, contributing to a gradual reduction of external indebtedness and a strengthening of Lithuania's external position.

C. The Currency Board Arrangement

7.   The CBA will continue to anchor macroeconomic policies. This arrangement provides a stable monetary environment, contributing to maintaining low inflation and bolstering confidence. In response to increased economic integration with the EU area, and as a necessary step toward the eventual participation in the Exchange Rate Mechanism (ERM) from the time of EU accession, the BoL and the government intend to switch the anchor currency from the dollar to the euro at the market rate of the day in early 2002, while maintaining the CBA. On June 28, 2001, the BoL announced that the date of the repegging will be February 2, 2002, and it will take place at the reference exchange rate of the U.S. dollar and euro announced by the European Central Bank (ECB) on February 1, 2002. The announcement was made seven months in advance, in order to give adequate time to the population and enterprises to prepare for the switch. The BoL has discussed technical aspects of the repegging with the IMF and the ECB.

8.   Continued monetization is envisaged during the program period, owing to the strong confidence in the CBA. Greater competition in the banking system, together with improved domestic business opportunities, would facilitate a revival in credit to the private sector. Moreover, to help ensure monetary restraint, the program envisages limited reliance on privatization proceeds for budgetary financing. Further developments of monetary policy instruments are planned with a view to approaching ECB requirements. Over the medium term, the BoL envisages a gradual harmonization of minimum reserve requirement standards with those of the ECB. No reductions in required reserves are being envisaged at this time (Table 1). Treasury accounts were shifted from commercial banks to the BoL on June 30, 2001. The Treasury and the BoL will work closely to improve forecasts of cash flows, and coordinate these flows. The BoL will work to strengthen the functioning of the interbank and foreign exchange markets in order to ensure smooth and effective liquidity management. To safeguard monetary restraint, the program features performance criteria on the net foreign exchange coverage under the currency board arrangement and on minimum required bank reserves.

D. Fiscal Policy and Fiscal Structural Reforms

9.   The government's efforts to build on the fiscal consolidation achieved so far will remain at the center of the program in 2001-02. Continued fiscal adjustment will boost the credibility of the CBA and lead to further reductions in borrowing costs for the public and private sectors. Higher savings generated by the general government will also make significant contributions to national savings, liberating resources for investment and strengthening the external position. The accelerating economic recovery and concomitant strengthening of private sector demand should facilitate the task of deficit reduction. Tax reforms must be consistent with the pace of the targeted deficit reduction, taking into account the need to accommodate new expenditure commitments while maintaining an adequate level of social expenditures. The objective of achieving a balanced budget (excluding the cost of pension reform) at the time of EU accession, assumed in 2004, when the economy could be growing at its potential, would help assure medium-term external sustainability.

10.  The government intends to introduce changes in the tax system, with the aim of easing the tax burden to promote employment-generating growth and investment, eliminating loopholes to make the system transparent, and implementing municipal taxes to strengthen municipal finances. The first phase of the tax reform will mainly focus on the corporate income tax (CIT), personal income tax (PIT), and consumption taxes. Tax reform measures after 2002 will include further steps in reforming consumption taxes, in accordance with EU requirements, and extending the coverage of the real estate tax. A further reduction in the PIT could be considered depending on progress in establishing the administrative capacity of municipalities to levy taxes and the overall strengthening of municipal finances. Reforms of the tax system will be complemented by improvements in tax administration (paragraph 18).

11.   On the expenditure side, there are a number of priorities and new commitments that must be faced: the costs of EU and NATO accession, the legal commitments to finance education, the closure of the Ignalina nuclear power station, environmental remediation, pension reform, improvements to social expenditure, and clearance of remaining expenditure arrears. The savings and land restitution programs represent additional substantial obligations that could only be fulfilled over a long period of time, given other pressing expenditure needs; hence, cash payments on their account will be limited to about 0.1 percent of GDP in 2001-02. The public investment program will be geared towards infrastructure, environmental and other projects necessary for EU accession, and further improvements in education. After a period of strong adjustment and deep expenditure cuts, there is little immediate scope for further reductions if essential services and social expenditures are to remain adequate; however, the government will pursue expenditure rationalization and seek gains in efficiency across the board.

12.   The fiscal deficit target for 2001 of 1.4 percent of GDP remains appropriate. In July, Seimas adopted the Law on Amendment to the Law on Approval of Financial Indicators of the State Budget and the Budgets of Municipalities for 2001 of the Republic of Lithuania, by which the national budget (the state budget and municipal budgets) was adjusted. The revised law aims at reallocating expenditure while keeping the budget deficit target unchanged. The revision increases both revenue and expenditure by LTL 80.3 million (0.17 percent of GDP). In the event that revenue shortfalls were to emerge later in the year, the government is committed to take necessary measures to ensure that the budget deficit target is achieved. The financing of the general government deficit remains as initially budgeted. Privatization proceeds of 2.7 percent of GDP will be largely deposited outside commercial banks. Net foreign financing will amount to 0.8 percent of GDP, with the largest part--the February eurobond proceeds equivalent to 1.5  percent of GDP--already having been disbursed. Net domestic financing of -2.1 percent of GDP will reflect mainly the build-up of government deposits. The modest general government deficit and a strict limit on guaranteed debt will lead to a modest increase in public and publicly guaranteed debt from 29 percent of GDP in 2000 to 29.6 percent in 2001. The government will make its best effort to refrain from providing guarantees for the investment projects of Mazeikiu Nafta, which could be required by the privatization agreement.

13.   The 2002 budget will incorporate the first phase of the tax reform, and reflect further expenditure consolidation, while making room for new expenditure demands. General government revenue is estimated to decline by around 1.5 percent of GDP due to slow growth of the tax bases of the payroll tax, PIT, and excises (0.8 percent of GDP), a decline in nontax revenue of 0.2 percent of GDP, and the net negative impact of the first phase of the tax reform of around 0.5 percent of GDP. Tax reforms will continue in 2002 when the government plans to implement a package including the following elements: (i) from January 1, 2002, an increase of the tax exempt minimum (TEM) of the PIT from LTL 214 to LTL 250; ii) a reduction of the CIT rate from 24 percent to 23 percent, alignment of the CIT with EU requirements, elimination of most exemptions and tax breaks, and introduction of accelerated depreciation for some cases (basically in total revenue neutral changes); (iii) a realignment of consumption taxes with a view to bringing them in line with EU requirements, including the elimination of certain VAT exemptions (+0.1 percent of GDP), a reduction in the turnover tax (-0.2 percent of GDP), a change in excise collection procedures (-0.2 percent of GDP), and an increase in excises on diesel fuel which will be offset by exemptions granted to farmers; (iv) some of the excise taxes incompatible with EU requirements will be converted into specific taxes (revenue neutral); and (v) a reinstatement of the capital gains tax. In addition, the government will introduce changes to the tax system to improve transparency and eliminate loopholes. Finally, the government will avoid any broadening of the coverage of the lump-sum taxes on specific professional activities (patents) that would entail revenue losses as a result of substitution from higher-yielding taxes.

14.   The government will seek ways to reduce the overall expenditure to meet the deficit target, mainly through expenditure rationalization at the level of the state budget. A budget deficit target of about 1.3 percent of GDP would be consistent with continued progress in external adjustment. In the event the tax reform package will be substantially different from the one described in paragraph 13, the necessary expenditure adjustments would be made to reach this deficit target. For the program to remain credible, these adjustments will have to be kept realistic and feasible. The composition of expenditure restructuring and a more precise quantification of EU accession costs will be discussed with the IMF staff in the context of the first program review. The deficit could be financed comfortably from domestic and external sources.

15.   The efforts to strengthen municipal finances will focus on defining more clearly the functions of municipalities, strengthening expenditure management, and finding new sources of revenue. These measures would help address the structural causes of municipal expenditure arrears, thereby helping clear outstanding arrears by end-2002 and preventing their reemergence. A special government commission has been established to define local governments functions, including those mandated by the central government, and their financing sources. A set of comprehensive measures to overhaul municipal finances will be prepared by the time of the completion of the first program review (December 2001). The Law on amendment of the Law on the Methodology of Establishment of Revenues of Municipal Budget, which will establish more precise and adequate principles for balancing revenues of municipal budgets with regard to the implementation of state mandated functions and the procedure for allocating funds, will be submitted to Seimas by end-September 2001. Furthermore, the Cabinet-level commission on expenditure arrears will continue its monthly monitoring of the clearance of municipal arrears. The State Control will be asked to conduct a performance audit of municipalities and to provide recommendations on how to resolve the problem of expenditure arrears. In this context, municipalities which incur arrears due to insufficient administrative capacity and weakness in expenditure management will be provided with technical assistance. Legislation giving municipalities more discretion in setting tax rates and fees accruing to local budgets--including a real estate tax of up to 1.5 percent of assessed property values--will be submitted to Seimas by end-December 2001. This would lead to greater predictability in revenue and flexibility in the financial management of municipalities. In addition, the central government will not undertake any unconditional bail-outs: any financial transfers to municipalities to clear expenditure arrears will be part of a comprehensive financial restructuring plan. Transfers from the central government to municipalities earmarked for arrears clearance will be made in separate tranches; with each tranche conditional on the fulfillment of scheduled plans for the reduction in the outstanding stock of arrears. The reduction of municipal arrears will be monitored via a structural benchmark under the program. Moreover, greater transparency will be introduced with quarterly publication of municipal financial statements, additional audits of municipalities with increasing arrears, and possible sanctions. As a general principle, the general government will strictly refrain from recourse to mutual debt cancellation or other netting or offset schemes, including with suppliers and tax payers.

16.   The finances of the Health Insurance Fund (HIF) will also be strengthened. The HIF will submit to the government proposed changes to procedures for pricing and classifying medical services and financial management of public health care institutions with assistance from the World Bank by December 2001. The government will also adopt a plan for streamlining the procedures for marketing and reimbursement of pharmaceuticals. In this regard, the HIF will submit to the government a revision to the list of pharmaceuticals subject to reimbursement by end-October 2001. Finally, three-year budgetary estimates of the HIF will be prepared by a joint committee including representatives from the Ministry of Health, Ministry of Finance, Prime Minister Office, and the Ministry of Social Protection by December 2001. The first program review will focus on the appropriate strategy ensuring medium-term sustainability of the HIF to be submitted to Seimas with the 2002 budget.

17.   A pension reform introducing a three-pillar pension system will start in 2003 comprising: (i) a pay-as-you go pillar; (ii) a mandatory contribution-defined second pillar financed by a diversion of at least 5 percentage points of the payroll tax for the younger cohorts of the population, with the middle age group to have an option to participate in the second pillar; and (iii) a voluntary, privately-funded pillar. As soon as Seimas has passed the reform of the pension system, the government will submit to Seimas a draft law authorizing private pension funds to manage the accumulated resources under the second pillar and a draft amendment to the current Law on Social Security. The government plans to finance the transition cost of the pension reform, currently estimated at about 1 percent of GDP per year for the first three years of operation, partly by privatization proceeds. To help finance the transition to the new pension system, an amendment to the Privatization Law setting up the Reserve Stabilization Fund (RSF) in line with the recommendations of the July 2000 technical assistance mission of the Fiscal Affairs Department of the IMF will be submitted to Seimas by end-September 2001. This amendment will authorize the government to set up the RSF for accumulating privatization proceeds and use the accumulated proceeds to finance the pension reform. The regulations of the RSF will be approved by the government by end-November 2001. These regulations will include provisions on: (i) major principle of asset management and audit procedures; (ii) Seimas approval of the annual budget of the RSF in the context of the approval of the national budget; and (iii) a requirement to publish annual reports and results of the audit of the RSF. The government is committed to maintain the improved financial position of SoDra and to take steps to reduce pensions paid directly by the state budget.

18.   The government will further modernize and strengthen its tax administration and general administrative capacity. Amendments to the Law on Tax Administration were submitted to Seimas in April 2001. The draft revises the system of penalties, tax arrears write-offs and deferrals. The Ministry of Finance will resubmit to the government a draft law merging the payroll tax collection function of SoDra with the State Tax Inspectorate. A new draft of the law on merging the State Tax Inspectorate with the payroll tax collection of SoDra will be resubmitted to Seimas. In addition, the Ministry of Finance has established two new departments, strengthening its administrative capacity to manage and monitor grants and co-financing of EU-related projects. In this regard, estimates of EU grants and the needed cofinancing will be included in the 2002 draft budget. To avoid the accumulation of expenditure arrears of the state budget, the Treasury will improve the control over expenditure commitments of appropriation managers on a monthly basis. Moreover, to ensure effective management of the state financial resources, specialists of the Ministry of Finance and the BoL will implement joint measures for the forecasting and management of these resources.

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

E. Other Structural Policies

20.   The government is committed to continue to implement measures to improve further the business environment, which is key for enhancing the investment climate and attracting foreign direct investment. Following the recommendations of the sunset and sunrise commissions, the market regulation system has been streamlined with the centralization of business inspection functions in two main agencies, and the sunset commission has assumed formally the function of monitoring administrative barriers. Future steps in the government's program include the streamlining of registration and liquidation procedures for companies through amendments to the current law by September 2001; the passage by Seimas by end-2001 of legal amendments that will put in place national accounting standards compatible with EU regulations; formal training for administrators and judges on new bankruptcy procedures; preparation of a manual on bankruptcy and restructuring procedures by mid-2002; and the simplification of the restitution of land ownership rights by October 2001.

21.   The government is committed to continue with its program to rationalize government agricultural programs and financial support to agriculture, with a view to EU accession. Considerable progress was made in 2000 to reduce government subsidies via price supports that led to overproduction. These efforts will continue in 2001-2002 in line with commitments to the WTO and World Bank. Through greater oversight and accountability, the government will aim to reduce the losses of the Agricultural and Food Products Market Regulation Agency (AFMRA) stemming from market support, procurement and storage operations, which diverts scarce resources from rural development programs, rural infrastructure and EU cofinancing. As such, the government will facilitate the implementation of EU SAPARD programs, including with measures to ensure greater cofinancing possibilities in rural areas. The Ministry of Agriculture will continue its information campaign on the modalities of cofinancing of SAPARD grants by the private sector, provide training to farmers, and collaborate with commercial banks.

22.   A number of measures will be taken to increase labor market flexibility, including implementation of flexible forms of employment and remuneration, as well as short-term and training contracts. To codify the existing system of regulation, the Unemployment Insurance Law and Labor Code will be submitted to Seimas in 2001. In addition, the government will continue its commitment to targeted job training programs that are defined by the projected demand in the private sector. Moreover, the social safety net will be reinforced by better targeting of social assistance, so as to protect the unemployed, especially the long-term unemployed and least advantaged segments of the population, thus contributing to social cohesion and support for the reform process.

23.   The privatization program is to be substantially completed in 2001-02, leading to enhanced efficiency and promoting the overall restructuring of the economy. The privatizations for the Savings Bank and LISCO were completed; the buyers pledged to invest an additional LTL 150 million in the Savings Bank over the next two years and US$60 million in LISCO during the next three and a half years. The cargo business of LISCO, which was not sold during the privatization, will be offered for sale in a new tender to be organized by end-June 2002. A tender for advisory services in the privatization of the Lithuanian Airlines will be completed by October 1, 2001, with the company to be restructured and prepared for privatization by end-2001. The sale of Lithuanian Airlines is expected to be completed by April 2002. A reorganization of Lithuanian Railways (LRR) will continue according to the plan approved by the government on May 3, 2001, with attention to be given to the separation of freight and passenger services from infrastructure, clarification of the structure of management with a view to improving the financial position, and implementation of a public service obligation concept. Reorganization of the railways is a complex task that will require considerable efforts, and the government plans to privatize LRR by end-2003. The government will also continue efforts to privatize small and medium business and land plots, as well as small residual shareholdings (less than one-third government stake) in some 1,200 companies.

24.   In the energy sector, the restructuring and privatization of Lithuanian Power Company (LPC) and Lithuanian Gas (LG) will continue during 2001-02. Amendments to the Law on Restructuring LPC passed by Seimas in June 2001. Registration of LPC successor companies is expected to be completed by the end of 2001. Distribution and generation companies will be offered for sale by end-February 2002--a condition under the World Bank SAL for the distribution companies--with closing of privatization transactions targeted for end-June 2002. The government will make every effort to enforce claims on Belarus for electricity deliveries, as well as monitor new export arrangements to ensure that no new arrears are incurred. For LG, the company will be offered for sale in the second half of 2001, and closing of the privatization targeted for end-2001. In all of these privatization efforts, the government remains committed to ensuring transparency in the privatization process, including by the retention of international advisors and conducting the sales according to open, international tenders.

25.   Financial sector reforms will focus on the completion of bank privatization, strengthening of the supervision of financial institutions, and further improvements in legislation to promote a deepening of financial intermediation. The privatization of the Agricultural Bank (LZUB) remains a high priority. A tender for new privatization advisors was concluded in May. It is expected that a new LZUB privatization tender will be announced by end-September 2001. If the Swedish parent companies of Vilnius Bank and Hansabank, the new owner of the Savings Bank, complete a merger, one of the banks would be required to be divested so as to prevent excessive concentration of the banking system. A joint IMF-World Bank financial sector assessment (FSAP) mission is expected in the second half of 2001, in order to review the functioning, legal basis and stability of Lithuania's financial sector. The recommendations of this assessment mission will provide guidance for further steps to improve banking supervision and financial sector efficiency. In order to complete the appropriate legal framework for well-functioning financial markets, the Securities Insurance Law, in line with EU requirements, gradually increasing the protection for each investor up to €20,000 by 2008, and the General Financial Institutions Law have been submitted for Seimas' approval. The amendment to the Commercial Banking Law to speed up liquidation of banks undergoing bankruptcy proceedings has already been passed. The amendment to the Pension Fund Law which liberalizes the conditions for the establishment of the voluntary third pillar, and the Insurance Law in line with EU requirements which establishes similar standards for foreign and local entities have also been passed. Deeper financial intermediation will be promoted by improvements to legislation concerning collateral, repo transactions, and other financial instruments. In addition, the government will promote harmonized taxation of the full range of financial instruments.

III. Phasing, performance criteria, benchmarks, and reviews

26.   The program will be monitored on the basis of quarterly quantitative performance criteria and indicative benchmarks, a set of structural policy benchmarks, and three reviews by the IMF Executive Board. Quarterly quantitative performance criteria and benchmarks, consistent with the economic policy targets described above, have been proposed for the currency board arrangement, fiscal policy, and external debt management (Tables 1 and 2). The performance criteria relating to the currency board arrangement are designed to ensure its maintenance. The quantitative performance criteria and benchmarks relating to the general government budget aim to ensure that the fiscal stance is appropriately tightened as intended, domestic loan guarantee activities limited, and general government budgetary arrears cleared. The quantitative performance criteria on external debt have been determined with a view to safeguarding prudent external debt management and scaling back government guarantees for non-government borrowing. The definitions of all quantitative targets are provided in the Technical Memorandum of Understanding (Annex I). The structural policy benchmarks focus on actions considered particularly important for supporting the targeted budget adjustment and other key structural policy actions (Table 3). The SBA contemplates access of SDR 86.52 million with a possibility of seven equal purchases, the first one is conditional on approval of the arrangement by the IMF Board, and the remaining six are linked to the quarterly test dates and the completion of the reviews.

27.   The quantitative targets for end-September 2001 and end-December 2001 are performance criteria (except for the indicative targets on domestic guarantees and central government arrears, which are benchmarks), while the targets for end-March 2002 and end-June 2002 are indicative targets. Performance criteria, benchmarks for domestic guarantees and central government arrears, and structural benchmarks for end-March 2002 and end-June 2002 will be set at the time of the first review. A quantitative benchmark for the reduction of municipal arrears will be introduced at the time of the first review, following preparation of a set of measures for strengthening municipal finances.

28.   The first program review will be based on end-September 2001 outcomes and is expected to be completed by end-December 2001. The review will focus mainly on the 2002 budget, municipal finance reform, and progress in privatization. The second review will be based on end-March 2002 outcomes and is expected to be completed by end-June 2002.


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

June 26, 2001

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

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

Maintenance of exchange rate under currency arrangement

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

Cover for currency board arrangement

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

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

Required reserves of the banking system

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

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

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

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

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

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


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

    (i) monetary gold holdings;

    (ii) holdings of SDRs;

    (iii) reserve position in the IMF; and

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

11. Excluded from gross foreign reserves are:

    (i) capital subscriptions to foreign financial institutions;

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

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

    (iv) assets in nonconvertible currencies; and

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

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

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

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

    (ii) the outstanding use of Fund credit.

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

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

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

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

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

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

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

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

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

    • Net nonbank domestic financing is defined as the sum of: (i) the change in the holdings of government securities by nonbanks, calculated as the difference between the change in the stock of government securities and the change in the holdings of government securities by the banking system; (ii) any net direct borrowing from nonbank institutions, including by budgetary organization and appropriation managers.

  • Net privatization proceeds are defined as the cash receipts from asset sales by the general government from abroad or domestically minus privatization-related expenditure. Expenditures necessary for, and directly related to, the privatization of state-owned enterprises shall be deducted from gross privatization proceeds and will not be classified as expenditure above the line in the fiscal accounts. These are limited to (i) outlays for consultants and advisers, (ii) increases in authorized capital prior to the sale of an enterprise, and (iii) outlays due to assuming the clean-up of environmental damages as identified in specific privatization agreements.

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

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

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

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

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

III. Performance Criteria on External Debt

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

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

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

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

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

IV. Reporting

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

Information on money and banking

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

  • international reserves;

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

  • the structure of bank assets and liabilities;

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

28.  In line with SDDS requirements, the data on international reserves of the Bank of Lithuania will be provided to the Fund on the 7th day after the end of the month at the latest; the balance sheet of the Bank of Lithuania will be provided to the Fund on the 14th day after the end of the month at the latest throughout the program period in the agreed format. The other data referred to in paragraph 28 will be provided to the Fund on the 24th day after the end of each month at the latest throughout the program period in the agreed format.

General government budget implementation and financing

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

  • below the line financing of the consolidated general government;

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

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

  • revenue and expenditure of all extrabudgetary funds included in the calculation of the general government financial balance;

  • outstanding domestic government debt broken down by maturity and type of debt (direct and guaranteed), including disbursements and redemption;

  • domestic debt service;

  • use of resources borrowed abroad;

  • general government deposits held abroad;

  • disbursements and repayments of foreign loans;

  • borrowing by municipal governments;

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

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

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

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

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

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

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

Information on the External Sector

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

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

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

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

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

Mr. M. Jonikas
Vice Minister of Finance
Ministry of Finance
Mr. A. Kregzde
Vice Governor
Bank of Lithuania

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