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Federal Republic of Yugoslavia—Letter of Intent, Revised Memorandum of Economic and Financial Policies, Technical Memorandum of Understanding

September 4, 2001

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

Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street
Washington DC 20431

Dear Mr. Köhler:

The implementation of policies under our stabilization and reform program for 2001, which is supported by a stand-by arrangement approved on June 11, has been firm, setting the basis for continued reforms and a sustained improvement in the living standards of our citizens. The attached Revised Memorandum of Economic and Financial Policies—which updates and supplements the Memorandum attached to our letter of May 25, 2001—describes our economic objectives and policies for the remainder of this year. On this basis, we request: (a) a waiver for the nonobservance of a performance criterion on new non-concessional external debt for end-June; and (b) completion of the first review under the stand-by arrangement.

We believe that the policies and measures described in the attached memorandum are sufficient to achieve the program objectives, but we stand ready to take additional measures and seek new understandings with the Fund, if necessary, to keep the program on track. We will remain in close consultation with the Fund in accordance with the Fund's policies on such consultations, and will provide the Fund with all information that it requests to assess the implementation of the program. The program will be reviewed by the Fund by November 15, 2001, and February 15, 2002. The next review will be the occasion for reaching understandings on bank restructuring, the basic parameters of fiscal policy for 2002, and electricity pricing policy.

Yours sincerely,

Miroljub Labus
Deputy Prime Minister and Minister
of Foreign Economic Relations
Federal Repulic of Yugoslavia

Mladjan Dinkic
National Bank of Yugoslavia
Bozidar Djelic
Minister of Finance
Republic of Serbia
Miroslav Ivanisevic
Minister of Finance
Reuplic of Montenegro

Federal Republic of Yugoslavia—
Revised Memorandum of Economic and Financial Policies

I. Introduction

1. This memorandum updates and supplements the Memorandum of Economic and Financial Policies (MEFP) attached to the Letter of Intent of May 25, 2001. It reports on economic performance and policy implementation so far under the Fund-supported program for 2001 and updates as needed the economic objectives and policy agenda under the program for the remainder of this year. Annex A to this memorandum describes the quantitative performance criteria and indicative limits for the remainder of the program; Annex B lists the prior actions and preconditions for consideration of the review by the IMF Executive Board, and the structural performance criteria and benchmarks for the remainder of the program; and Annex C defines the performance criteria and indicative targets and describes the reporting arrangements.

II. Background

2. Policies under the program have been firmly implemented, thereby creating the necessary conditions for continued reforms and improved living standards. Fiscal and monetary policies have been on track for FRY as a whole, despite a higher than envisaged fiscal deficit in Montenegro. In Serbia, a major fiscal reform has been put in place, involving the streamlining of a complex tax system and the integration of a large number of extrabudgetary programs into the budget; the extremely restrictive foreign exchange and trade systems have been almost completely liberalized; a bank resolution strategy has been formulated and its implementation has begun, with support from the Fund, the World Bank, and bilateral donors; and a new privatization framework has been adopted, in cooperation with the World Bank, setting the basis for accelerated privatization with transparent procedures. In Montenegro, where significant institutional reforms have been adopted over the past several years with assistance from bilateral donors, further progress has been made in bank restructuring and privatization

3. Donor and creditor support is key for FRY's success in reform. At the Donor Conference that was held on June 29 in Brussels, US$1.3 billion was pledged, slightly more than originally envisaged. The timely disbursement of these funds—especially in the form of budgetary support in the third quarter of this year—is crucial, given the need to cushion the social costs of the rapid transformation of large sectors of the economy. Moreover, the external outlook will remain highly uncertain pending a restructuring of debt obligations to official bilateral and commercial creditors on concessional terms.

III. Economic Objectives and Policies for the Remainder of 2001

4. The original macroeconomic objectives of the program remain broadly appropriate. Recent output developments are in line with the program target of 5 percent real GDP growth in 2001, after taking into account the recovery in agricultural output from last years' severe drought and the increased activity in transportation and other services (tourism in Montenegro); moreover, some strengthening of industrial output and exports in the second half of the year is likely, in lagged response to the removal of the sanctions. As regards inflation in Serbia, the upper end of the target range of 30-35 percent still appears achievable in light of the progress so far in lowering core inflation, albeit with difficulty owing to further adjustments in administered prices. The inflation rate in Montenegro is likely to reach about 15 percent in 2001 (expressed in DM terms), against a program target of 6½ percent, reflecting the larger than expected effects of administered price increases and the lagged effects of the rapid rise in wages through late last year; since then, wages have stabilized. Developments in the external accounts so far this year point to a somewhat higher than programmed accumulation of foreign reserves, as increased net inflows of services and private transfers are projected to offset a shortfall in net capital inflows. The allocation of gold and foreign exchange reserves of former SFRY held with BIS has further added to NBY's gross foreign exchange reserves, which are now expected to reach about US$1.0 billion by end-2001 (around 2 months of projected imports of goods and services), US$0.2 billion more than originally targeted.

5. The key policy targets under the program—with only minor adjustments—remain appropriate as well as achievable. In the fiscal area, government borrowing from the banking system will be limited to the equivalent of no more than 0.8 percent of FRY's GDP in 2001, or up to 0.2 percent of GDP more than originally programmed, to accommodate spending on bank restructuring costs in excess of the existing budgetary allocation. This will be achieved through containment and prioritization of spending as well as intensified revenue efforts at all levels of government. In the area of monetary policy, the original NDA targets will be adjusted to reflect the possibility of higher government borrowing to finance bank restructuring-related spending, while the targets for reserve money and NFA will be raised to take into account the strengthening of the demand for the dinar and the associated external overperformance so far. Moreover, structural reform will continue. In Serbia, the authorities intend to proceed with the implementation of a bank restructuring strategy and accelerate the privatization process on the basis of a new privatization framework. In Montenegro, besides addressing severe fiscal problems, the authorities intend to make progress in bank restructuring and privatization.

A. Fiscal Policy

6. Fiscal policy has been broadly in line with the program so far, notwithstanding a higher than targeted fiscal deficit in Montenegro. The consolidated general government in the whole of FRY recorded a cash surplus (after foreign grants, foreign borrowing and privatization receipts) of 0.4 percent of annual GDP in January-June 2001; by comparison, the program allowed for a cash deficit of 0.3 percent of GDP during the same period. The federal government maintained a cash balance, although at the cost of accumulating some arrears; the Serbian consolidated government registered a cash surplus of 0.6 percent of GDP; while the Montenegrin consolidated government incurred a cash deficit of 0.2 percent of FRY's GDP (3 percent of Montenegro's annual GDP), in addition to accumulating further arrears. Based on the revised fiscal program, the FRY consolidated general government deficit in 2001 (before grants, foreign borrowing and privatization proceeds) is projected to amount to 4.0 percent of GDP, of which 0.8 percent will be financed by domestic borrowing, 0.4 percent by privatization proceeds, 1.2 percent by foreign grants, and 1.6 percent by foreign borrowing. This compares with an overall deficit of 6.1 percent under the original program. The difference is explained by a shortfall in expected foreign-financed project spending and expenditure cuts in response to a shortfall in expected privatization receipts.


7. Most measures envisaged under the program have been implemented. Salaries have been frozen at the January level for the federal administration and at last October's level for the army, while wage payments in the whole federal government will be limited from 13 to 12 months salaries. Nevertheless, new arrears of about 1.2 billion dinars were accumulated during the first half of this year, owing to lower than budgeted customs duties and nontax revenue. However, with the adoption of the new tariff schedule—which involved an effective increase in tariff rates—and improved sales tax collection in June, the revenue performance is expected to improve to the budgeted level by year-end. To ensure that the fiscal stance is in line with the program, the authorities will also keep general services of the federal administration at their current level of spending (savings of 2 billion dinars) and reduce the administrative and procurement cost of the army (0.5 billion dinars). With a view to introducing civilian control of defense spending, the Operational and Financial Service, which is in charge of the accounting and payment orders for defense budget, will be transferred from the General Staff Headquarters to the Ministry of Defense by August 31, 2001. This will bring the execution of the defense budget directly under the control of the Minister of Defense, thereby enhancing fiscal transparency and efficiency.


8. Given expected spending pressures and a likely shortfall in privatization receipts, revised fiscal estimates point to a sizable fiscal gap in 2001. The cautious execution of the budget in Serbia generated a moderate cash surplus in the first half of 2001. Revenue performance was broadly in line with expectations, while expenditure was kept low in line with available resources, by strictly prioritizing spending. For the year as a whole, the budget target for revenue should be achievable, with a shortfall in excises being offset by overperformance with regard to income and sales taxes. Without corrective measures, expenditure is projected to reach 135½ billion dinars in 2001, 3 billion dinars more than budgeted, owing to pressures for increased spending in the remainder of the year. This reflects additional burdens stemming from higher than initially envisaged transfers to the social security funds (by 4.3 billion dinars, see ¶10), unanticipated lending to the electricity company for major maintenance operations (2 billion dinars) and to the commodity reserve for wheat harvest purchases (3.6 billion dinars), and additional spending on bank restructuring (of up to 1.4 billion dinars, or 0.2 percent of GDP in 2001, as explained in ¶21), which will be partly offset by previous overestimation of other expenditure items (other net lending, personnel expenditures, and lower interest payments, jointly amounting 9.4 billion dinars). Taking also into account a downward revision of expected privatization revenue (by 7 billion dinars, to 3 billion dinars) and assuming external financing as budgeted, the Serbian budget is faced with a financing gap of about 9 billion dinars (1.3 percent of GDP) in 2001. (In addition, based on commitments at the June 29 Donor Conference, about US$50 million of project-related spending, mostly for reconstruction, is expected to take place in 2001; this compares with an original program estimate of US$230 million. Since this portion of spending is completely contingent on disbursement of foreign aid, there is no impact on the financing gap.)

9. Significant additional foreign financing will be required to close the fiscal gap even after the adoption of corrective measures. The Serbian authorities have identified corrective fiscal measures that are estimated to yield 5 billion dinars (0.7 percent of GDP) in 2001: transfers and subsidies to enterprises and households will be postponed until more financing becomes available (4.0 billion dinars), personnel cost increases will be contained (0.8 billion dinars,) and material costs will be reduced (0.3 billion dinars). In addition, since more than 70 percent of the general reserve has been committed, a set of contingency measures of 3 billion dinars has been identified for adoption in the event of delays in privatization revenue or other unfavorable developments. The remainder is expected to be covered by higher foreign financing (2.6 billion dinars or 0.4 percent of GDP) and increased borrowing from the domestic banking system (1.4 billion dinars or 0.2 percent of GDP).

10. The social security funds are expected to require higher transfers from the budget than originally envisaged. The funds have so far managed to keep spending in line with revenues without incurring new arrears, but the tax measures adopted in June (introduction of the gross wage system and lowering of contribution rates) are now expected to lead to even greater loss of revenue from contributions than originally envisaged. The health care fund, which saw its drug procurement cost rise after the introduction of the unified sales tax of 20 percent, will therefore be allocated an extra transfer of 2.3 billion dinars to avoid a severe reduction in the level of services, and the pension fund will receive an additional transfer of about 2 billion dinars. The labor market fund should be able to clear some arrears accumulated earlier his year and operate according to its budget, on the basis of the originally budgeted transfer.

11. Further progress in fiscal reforms is envisaged for the remainder of the program period. While wide-ranging reforms have been successfully implemented in the fiscal area so far this year, the structural benchmark for end-June—that envisages the adoption by the health fund of a drug list consistent with WHO guidelines—was missed, owing to management changes at the fund. A commission is working to finalize such a list by end-September, 2001. Meanwhile, progress in public expenditure management has been steady but somewhat slower than originally envisaged. A draft Organic Budget Law is being prepared with the help of donors and should be adopted by year-end. In light of staff and other capacity constraints, progress in establishing a Treasury and consolidating the government accounts would be facilitated by enhanced technical assistance.


12. The government has adopted corrective measures to redress a difficult fiscal situation. A significant expenditure overrun in the Montenegrin budget—owing to higher than envisaged spending on subsidies and lending to enterprises—resulted in a larger than targeted budget deficit in the first half of 2001. At the same time, the budget transfers to the social security funds were lower than planned, leading to further arrears accumulation at both the health and labor funds. Based on revised revenue and expenditure estimates, and the latest projection of foreign grants (DM 92 million), the consolidated general government of Montenegro is estimated to have a financing gap of about DM 20 million in 2001. With a view to covering this gap and ensuring that the original program target of a balanced budget (after foreign grants) is achievable without further accumulation of arrears, the government has decided to: reduce hot meal allowances (DM 4.5 million), spending on contractual services (DM 5.2 million), facility maintenance and capital expenditure (DM 12 million), and subsidies to the enterprises after the food price liberalization in August (DM 4.9 million). The Government of Montenegro has also launched an offensive against the gray economy, involving: the requirement of immediate registration by all traders and for all taxable goods to avoid stiff penalties; enhanced monitoring of noncustoms border points by Montenegrin police; a duty-drawback scheme for goods in transit to Kosovo; the installation of cash registers in all 7,500 shops by November (4,500 by end-August); and the introduction and enforcement of excise stamps. Together these measures will fill the gap, while creating a contingency reserve of about DM 7 million, to allow for a possible shortfall in foreign financing. In addition, the Montenegrin authorities, in coordination with the authorities in Belgrade, intend to work toward harmonizing Montenegro's customs tariff schedule with that of Serbia, with a view to both raising revenue for the budget and removing obstacles to trade between the two republics.

13. Notwithstanding progress in fiscal reform, a structural benchmark for end-June was missed. Specifically, although the government has already approved a draft Organic Budget Law, political developments prevented its timely consideration by the parliament. In the event, the law was approved by parliament on August 8. An interim Treasury will be set up later this year and new drafts of tax codes will be discussed in the government in the next few months. In addition, with a view to addressing weaknesses in data on the financing of the budget, which have complicated the monitoring of fiscal developments under the program, the Ministry of Finance, with the assistance of a local auditing firm, will prepare detailed data on the financing of the budget by early September. Moreover, if the data continue to be of weak quality for program monitoring in the judgment of the Fund staff, the Ministry of Finance intends to retain a reputable foreign accounting firm to audit the financing of the budget and prepare a report by mid-November 2001. Related fiscal transparency issues will be an important element of the discussions on the next review under the stand-by arrangement.

B. External Debt Management

14. To minimize fiscal as well as balance of payments pressures stemming from the servicing of new external loans, the federal and republican authorities remain committed to limiting the recourse to non-concessional external borrowing. In this respect, a guarantee extended for US$7.3 million of non-concessional borrowing by Montenegrin Airlines is not expected to be exercised given the company's favorable business prospects. Nonetheless, the use of such guarantees will be eschewed in the future. In addition, the Serbian government intends to borrow up to the equivalent of US$50 million, under relatively favorable terms, for the rehabilitation of the ailing energy sector. The projects—comprising investments and reparation works in the lignite mills and power stations—should achieve improvements in the power supply in the short run, thus having an immediate positive impact on the living conditions of the population. This financing operation, alongside continuing efforts to raise electricity prices and reduce operational costs, is expected to place the company on a viable commercial footing.

C. Wage and Price Policies

15. The federal and republican authorities remain committed to preventing excessive wage growth and adjusting administered prices to reflect economic costs. A strict wage policy in the government sector—consistent with keeping real wages unchanged in real terms from last year—has been and will continue to be firmly implemented. In state enterprises in Serbia, a wage freeze introduced in January has been strictly observed, and the indicative ceiling on the wage bill of the 8 largest state companies for end-June was met. Wage increases in state enterprises in the remainder of the year will be limited to 10 percent, to be implemented not earlier than September, implying an upward revision of the indicative target for the wage bills in those companies at end-September and end-December 2001. These wage increases will be conditioned on progress in reducing operational costs and improving profitability. Meanwhile, the electricity price in Serbia was more than doubled through adjustments in April and June, and will be raised further by 15 percent on October 1, 2001; in addition, the prices of gasoline, pharmaceuticals, tobacco and alcohol were adjusted in July and the price of bread was raised in August. In Montenegro, electricity and telecommunication prices were raised in April and June, respectively, and food prices were raised in August.

D. Monetary and Exchange Rate Policy

16. The NBY has revised the financial program targets, to take into account a strengthening of the demand for the dinar and to lock in some of the external performance. Following the adoption of a managed float at the beginning of this year, the exchange rate for the dinar has remained broadly stable against the euro, while the NBY has continued to accumulate NFA through net purchases from the foreign exchange market. This is explained by the larger-than-programmed decline in the NDA of the NBY, owing to fiscal overperformance, and the stronger-than-targeted growth in currency in circulation, which reflects improved confidence in the currency. With a view to supporting an output recovery while safeguarding the progress in reducing inflation, the NBY has raised the target for reserve money growth to 46 percent during 2001 (from 26 percent under the original program) and the target for NDA growth to the equivalent of 25 percent of end-2000 reserve money (from 18 percent under the original program). The target for NFA (excluding the effects of distribution of former SFRY foreign assets) has been accordingly raised by US$39 million for end-2001. In the event of higher-than-projected NFA, the NBY will consult with the Fund staff on the implications for credit policy and—if the NFA overperformance does not appear to reflect increased money demand—will maintain the NDA below the program ceiling.

17. The NBY will gear exchange rate policy to protecting external competitiveness and avoiding the emergence of `exit' problems. The current level of the exchange rate remains appropriate, as indicated by the continued accumulation of official reserves through purchases from the market and the fact that the real exchange rate is still somewhat depreciated in relation to historical levels. However, in light of the continuing real appreciation of the dinar, and the fact that a worsening of external competitiveness is reflected in current account flows with a considerable lag, the NBY will manage exchange rate policy with a view to limiting the loss of cost competitiveness and avoiding exit problems associated with an effective pegging of the exchange rate. Owing to uncertainty about the external outlook and underlying position, exchange rate policy will continue to be reviewed quarterly under the program.

18. In line with progress in restructuring the banking system, the NBY is putting in place a plan to reform monetary policy instruments. In particular, the NBY intends to (a) abolish the supplementary reserve requirements in the form of compulsory purchases of securities issued by the NBY and the electricity company by not renewing the expiring securities in the coming months; and (b) establish a unified required reserve ratio for dinar and foreign currency deposits that is significantly lower than 24.5 percent by January 1, 2002, in consultation with the Fund staff. As progress is being made toward cleaning up the banking system and a more efficient money market develops, the NBY will increasingly rely on open market operations in dinars and foreign exchange for the conduct of monetary policy.

E. Bank Restructuring

19. Consistent with policy commitments in the MEFP of May 25, 2001, significant first steps have been taken toward cleaning up and restructuring the banking system in Serbia. Based on detailed diagnostic reports—undertaken by the NBY with the assistance of foreign donors—of 28 banks that had been classified as insolvent on the basis of an earlier NBY survey, these banks have been re-categorized as healthy (A), needing enhanced supervision (B), insolvent with some systemic importance or potential economic value (C), and insolvent in need of liquidation (D). A bank restructuring strategy was completed by mid-May 2001, and the banking system was intervened on June 15. Of the 28 banks, 7 banks that were found to be category D were delicensed and had procedures for their liquidation initiated; 11 banks (including 5 of the largest banks) were identified as category C, for consideration for possible treatment by the BRA. Of the remaining banks, 6 banks, including one of the largest banks, were considered to be category B and were placed under intensified NBY supervision, and another 4 banks were considered to be category A and not in need of further action. NBY subsequently sent 4 of the largest banks (Beobanka, Beogradska Banka, Investbanka, and Yugobanka, classified as category C) to the BRA for possible rehabilitation. These banks now operate under new management and control by the BRA.

20. Some key steps in the bank restructuring process are envisaged for the coming months. Specifically, by September 15, the NBY will (a) refine, in close coordination with the BRA and in consultation with Fund and World Bank staff, its pricing matrix to be used to estimate the total costs and fiscal needs for bank restructuring, and (b) recommend either immediate liquidation or possible rehabilitation (through the BRA) of the remaining 7 (of the 11) banks that were found to be category C banks. Moreover, the BRA will (a) by September 15, establish the potential validity of private nonguaranteed claims (including off-balance sheet items) on banks under its control, and (b) by October 15, develop rehabilitation/resolution plans for the 4 large banks under its control. These plans should include (a) monthly cash flows and operational losses during the rehabilitation period with a view to assessing progress toward achieving core profitability; (b) future business strategies; (c) the fiscal costs of restructuring, which will critically depend on progress in securing creditor haircuts, and (d) a recommendation on whether the bank should be rehabilitated or closed. On this basis, by end-October, the Board of Directors of the BRA, will recommend to the NBY, under Articles 7 and 22(a) of the law governing its operations, whether the banks should be subjected to a rehabilitation plan or liquidated. Bank rehabilitation will be undertaken only if it is expected to produce a viable bank with good prospects for privatization; and can be implemented with identifiable fiscal resources. If this does not appear to be achievable based on performance during the first six months of a rehabilitation program, the banks will be closed and liquidated. Moreover, the activities of banks under rehabilitation will be strictly controlled by the BRA, in accordance with ¶39 of the MEFP of May 25, 2001, with a view to containing further losses and limiting fiscal costs. Progress in bank restructuring will be the subject of the next review under the stand-by arrangement.

21. Further changes in the legal and institutional framework are envisaged to restructure and strengthen the banking system. The federal parliament is expected to approve, by end-September 2001, changes in the Law on the Financial Rehabilitation, Bankruptcy, and Liquidation of Banks to allow BRA to perform the functions of a bank liquidator. A revised deposit insurance scheme, designed to strengthen confidence in a restructured banking system, is another priority. To reduce moral hazard and enhance the credibility benefits from its adoption, such a scheme will be introduced once the solvency of the banking system has been restored through the closure of insolvent banks and the restoration of profitability in banks that have undergone restructuring.

22. The social and economic costs of bank resolution will be considerable. With a view to alleviating the social hardship associated with bank restructuring within tight fiscal constraints, the authorities will establish a social program to support and retrain bank employees who become redundant as a result of the restructuring or closure of banks. On the assumption that 5,000 workers will qualify for such assistance and retraining, the budgetary cost in 2001 is estimated at 600 million dinars. The payout of deposit insurance to household depositors in cases where banks have been (or will be) closed is expected to cost another 500 million dinars. These costs, along with BRA's operational expenses, are expected to be covered by an existing allocation of 600 million dinars in the Serbian budget as well as by additional budgetary allocations of up to 1.4 billion dinars; the ceilings on the NDA of the NBY and bank credit to the FRY consolidated general government have been adjusted upwards by up to that amount, with a view to accommodating such spending to the extent that it exceeds the existing budgetary allocation. The fiscal costs of restructuring will be the subject of the next review under the current stand-by arrangement.

23. The NBY is strengthening bank supervision, with assistance from bilateral donors. A review of prudential regulations has been completed and, by end-December 2001, revisions to Articles 26 and 27 of the Law on Banks are expected to be approved by the parliament, to empower the NBY to issue regulations on bank supervision in line with the international practice. Implementing regulations are being drafted and are to become effective on January 1, 2002, covering, among other things, capital adequacy, loan classification and provisioning, internal control and audit, risk management, credit concentration, and investment in fixed assets as well as other banks and enterprises' capital. The NBY is also working with donors to strengthen the regulatory framework and capacity regarding on-site supervisions. Furthermore, regulations on on-site supervisions are under review and training courses are planned for the coming months.

24. The Central Bank of Montenegro (CBM) is making progress in restructuring the banking system and enhancing bank supervision. The largest commercial bank, Montenegro Banka, has been placed under an administrator and will be privatized or liquidated with no government capital injection; documents to invite investors will be ready by end-September, 2001. Diagnostic reports for the remaining 11 commercial banks in Montenegro will be prepared by end-August with assistance from bilateral donors, and decisions on their resolution (liquidation, rehabilitation, mergers, no action) will be made by end-September 2001. New CBM regulations on bank rehabilitation, bankruptcy, and liquidation are being prepared and will be adopted by end-September 2001. With assistance from bilateral donors, a new regulation, to be based on the Accounting Law, will introduce international accounting standards for banks by end-2001. Decisions on minimum capital requirements, credit concentration, asset classification, and bank licensing have come into force as of May 9, 2001. The reform of the Clearing and Settlement Bureau (ZOP) is continuing as envisaged under the program.

F. Private Sector Development

25. In Serbia, privatization is to proceed expeditiously on the basis of a new transparent framework. A new privatization law was adopted in June 2001, and by-laws and other regulations were put in place by mid-July as envisaged in the MEFP of May 25, 2001. On the basis of the new framework, the privatization of about 40 large socially owned enterprises, including three cement factories, has been initiated or will be initiated soon. With World Bank assistance, expressions of interest have been solicited for financial advisors for 16 enterprises grouped in four pools of 3-5 companies, with 11 companies grouped in 3 pools to follow in the coming weeks. It is envisaged that at least four (of the seven) contracts with investment advisors should be signed by end-October 2001, and at least one pool of enterprises should be offered for sale by end-December 2001. It now appears that privatization revenue of only 3 billion dinars will be achievable by end-2001 (compared with an earlier estimate of 10 billion dinars), mainly because of a delay in the sale of a large cement company under the old privatization law. The privatization process for the remaining 4,000 socially owned enterprises has been initiated as envisaged in the MEFP of May 25, and is expected to accelerate in 2002-03. A new bankruptcy law will be drafted with assistance from the World Bank, to strengthen creditor rights.

26. Labor market reforms will improve the business environment in Serbia. Amendments to the law on Employment that were adopted in April (a) harmonized benefits with the redefined wage for tax purposes and (b) reduced the amount and duration of the minimum statutory benefits for employment termination and unemployment. A draft new law on Labor Relations—to be considered by Parliament in September—is envisaged to (a) increase labor market flexibility, as only companies employing over 50 and retrenching more than 10 percent of their staff will be required to submit a justification, (b) reduce minimum severance payments from 6-12 months to 2-5 months, (c) allow for negotiations of collective agreements by any organization representing over 15 percent of total staff, (d) reduce maternity benefits from 5 years to 1 year, and (e) reduce the minimum annual leave days to 18.

27. Privatization is an important element of Montenegro's structural reforms. A mass privatization program will provide vouchers to some 95 percent of the population which will be distributed this September. These vouchers can be used to obtain shares in companies or they can be used to buy shares in 4-6 licensed privately-managed privatization funds that will use these vouchers to buy shares. This year some 29 percent of the shares of 227 companies will be offered for sale through the mass privatization scheme. In addition, a majority share will be sold in 15 large companies through international tender, and international investors will be offered a minority share in other companies which can be expanded to a majority interest. Expressions of interest for the telecom company have been received and may yield results early next year, and a first hotel is expected to be sold this year to a Slovenian investor.

G. Statistics

28. The FRY authorities intend to request an assessment by an IMF mission of FRY's compliance with international statistical standards. The report, which is to be issued to the IMF Board, will identify areas of potential improvement, including through Technical assistance from multilateral institutions and bilateral donors.

Use the free Adobe Acrobat Reader to view Annexes A and B (545 kb PDF file)


Federal Republic of Yugoslavia:
Technical Memorandum of Understanding

I. Introduction

1. This memorandum sets out the understandings between the Yugoslav authorities and staff of the International Monetary Fund (IMF) regarding the definitions of quantitative and structural performance criteria and benchmarks, as well as indicative targets, for the
stand-by arrangement (SBA) approved on June 11, 2001, as well as the related reporting requirements. To monitor developments under the program, the Yugoslav authorities will provide the data listed in each section below to the European 1 Department of the Fund, in accordance with the indicated timing. The quantitative performance criteria and indicative targets will be monitored on the basis of the methodological classification of monetary and financial data that was in place on December 31, 2000, except as noted below. For program purposes, the public sector consists of the consolidated general government (comprising the federal, Serbian Republican and local governments, the Montenegrin Republican government, the Serbian and Montenegrin social security funds, and the Serbian special budgetary programs) and the National Bank of Yugoslavia (NBY). The authorities will inform the Fund staff of any new funds or special extrabudgetary programs that may be created during the program period to carry out operations of a fiscal nature as defined in the IMF's Manual on Government Financial Statistics, and will ensure that these will be incorporated within the definition of consolidated general government. Quantitative performance criteria and indicative targets for end-September and end-December 2001 are specified in Annex A of the Amended Memorandum of Economic and Financial Policies (MEFP).

II. Quantitative Criteria: Definitions and Reporting Standards

A. Floor for Net Foreign Assets of the NBY

2. Definition. Net foreign assets (NFA) of the NBY consists of foreign reserve assets minus foreign reserve liabilities.

  • For purposes of the program, foreign reserve assets shall be defined as monetary gold, holdings of SDRs, the reserve position in the IMF, and NBY holdings of foreign exchange in convertible currencies. The assets should be under the effective control of, and readily available to, the NBY. Accordingly, excluded from foreign reserve assets are: frozen assets of the Federal Republic of Yugoslavia (FRY), undivided assets of the Socialist Federal Republic of Yugoslavia (SFRY), long-term assets, NBY claims on resident banks and nonbanks, as well as Yugoslav commercial banks located abroad, any assets in nonconvertible currencies, encumbered reserve assets pledged as collateral for foreign loans, reserve assets pledged through forward contracts, and precious metals other than gold. Monetary gold shall be valued at an accounting price of US$272.60 per ounce, and SDRs at SDR1 = US$1.3029. On December 31, 2000 the NBY's foreign reserve assets as defined above amounted to US$516 million, including gold valued at US$125 million.

  • For purposes of the program, foreign reserve liabilities shall be defined as any short-term loan or deposit (with a maturity of up to and including one year), swaps (including any portion of the NBY gold that is collateralized), and forward liabilities of the NBY—in convertible currencies to residents and nonresidents; IMF purchases; and loans contracted by the NBY after December 31, 2000 from international capital markets, foreign banks or other financial institutions, and foreign governments (with the exception of bridge financing for clearance of arrears to the EIB), irrespective of their maturity. On December 31, 2000, the NBY's foreign reserve liabilities, as defined above, to nonresidents were US$152 million and to residents were US$672 million.

  • All assets and liabilities denominated in convertible currencies other than the U.S. dollar shall be converted at their respective exchange rates against the U.S. dollar prevailing on December 31, 2000. All changes of definition or valuation of assets or liabilities, as well as details of operations concerning sales, purchases or swap operations with respect to gold shall be communicated to the Fund staff within one week of the operation.

3. Reporting. Data on foreign reserve assets and foreign reserve liabilities of the NBY shall be transmitted to the European 1 Department of the Fund on a weekly basis within four business days of the end of each business week. To facilitate program monitoring, the NBY will provide the data at the indicated constant prices and exchange rates, as well as at current exchange rates (Annex A). The NBY will report if any of the reported foreign reserve assets are illiquid or pledged, swapped, or encumbered.

4. Adjusters. For program purposes the reported net foreign assets will be adjusted downward pari passu to the extent that: (i) since January 1, 2001, the NBY has recovered frozen assets of the FRY, assets of the SFRY, long-term assets, and foreign-exchange-denominated claims on resident banks and nonbanks, as well as Yugoslav commercial banks abroad; and (ii) the restructuring of the banking sector by the Bank Restructuring Agency (BRA) involves a decline in NBY foreign-exchange-denominated liabilities to resident banks.

B. Ceiling on Net Domestic Assets of the NBY

5. Definition. For purposes of the program, net domestic assets (NDA) of the NBY are monitored on a monthly average basis and defined as the difference between reserve money (as defined in section E) and net foreign assets (as defined in section A), with the latter being converted from U.S. dollars into dinars at the program accounting exchange rate of US$1 = YUD 63.1659, which was the rate prevailing on December 31, 2000 and the exchange rates of the US$ vis-a-vis other currencies prevailing on that day. As of December 31, 2000, the domestic assets of the NBY so defined were valued at YUD 39,315 (Annex A). The monthly average of NDA is calculated as the difference of the monthly average of reserve money and monthly average of NFA. The monthly average of NFA for the program purpose will be adjusted so that the disbursements of World Bank program loans and EU macro-financial assistance in excess of funds needed to clear arrears to the EIB are counted as if they occur on the first day of the month.

6. Adjustor. The ceilings will be revised downwards by the amount that government expenditure on bank restructuring falls short of YUD1,987 million, but the adjustment is not to exceed YUD1387 million.

7. Reporting. The ceilings will be monitored on the basis of daily data on the accounts of the NBY, reporting foreign reserves assets and liabilities as defined under section A and reserve money as defined under section E supplied to the European 1 Department of the Fund by the NBY, within four business days of the end of each business week. To facilitate program monitoring, the NBY will provide daily NBY's foreign reserves liabilities as well as the amount and date of the disbursements of the World Bank program and EU macro-financial assistance in excess of funds needed to clear arrears to the EIB at the current and the agreed constant exchange rates.

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

8. Definition. The banking system comprises the NBY and the commercial banks, including all banks in Montenegro. The consolidated general government is defined above.

  • For program purposes, net credit of the banking system to the consolidated general government is defined as all claims (i.e., credits, securities, and other claims in both dinar and foreign currencies) of the banking system on the consolidated general government less all deposits of the consolidated general government with the banking system, including foreign currency deposits. Foreign currency deposits and foreign-currency denominated credits to the general government will be reported at the end-December 2000 exchange rates. Any holdings of government securities by commercial banks mandated by the NBY against reserve requirements above the actual amounts held at end-December 2000 (YUD 174 million) will be included in the credit of the banking system to the consolidated general government. Before undertaking any changes to reserve requirements, the NBY will consult with the Fund staff. (Net bank credit to the consolidated general government in Montenegro will be monitored on the basis of data supplied by the Montenegrin authorities; at end-December 2000, net credit of the banking system in Montenegro to the consolidated general government in Montenegro amounted to [minus DM 84.8 million.])

9. Reporting. The ceilings will be monitored from end-weekly data on the accounts of the banking system supplied to the European 1 Department of the Fund with a lag not to exceed two weeks.

10. Adjusters. For program purposes, the ceilings on net credit of the banking system to the consolidated general government will be adjusted downward by the cumulative increase in the stock of government debt held by the nonbank public (other than that related to the frozen foreign currency deposits), starting from January 1, 2001, and upward for any decrease. In addition, the ceilings will be revised downwards by the amount that government expenditure on bank restructuring falls short of YUD1,987 million, with the adjustment not to exceed YUD1,387 million. Furthermore, the ceilings will be adjusted to the extent that the credit of the banking system in Montenegro to the consolidated general government at end-December 2000 is revised from the currently-reported level of minus DM 84.8 million.

D. Ceiling on Change in Arrears

11. For program purposes, indicative targets will be set on the change in domestic arrears. Separate indicative targets will be set for the federal government, the consolidated general government in Serbia, and the consolidated general government in Montenegro.

12. Definition

  • For the purpose of establishing compliance with this indicative target, the federal government is defined to comprise all budgetary institutions financed from the federal budget, including the federal army and the federal pension fund for retired military personnel. The consolidated general government in Serbia is defined to comprise all budgetary institutions financed from the Serbian republican budget, the Republican Pension and Invalidity Insurance Fund for Employees, the Republican Pension and Invalidity Insurance Fund for Self-employed, the Republican Pension and Invalidity Insurance Fund for Agricultural Workers, the Republican Health Insurance Fund, the Republican Labor Market Agency, all republican special directorates, the Serbian Development Fund, and all other budgetary and extrabudgetary funds created by the government of Serbia existing before or created during the period of the program. The consolidated general government in Montenegro is defined to comprise all budgetary institutions financed from the republican budget, the Republican Pension and Invalidity Insurance Fund, the Republican Health Insurance Fund, the Republican Labor Market Fund, and all other budgetary and extrabudgetary funds created by the government of Montenegro existing before or created during the period of the program.

  • The outstanding stock of domestic arrears comprises wage and pension arrears; arrears with respect to accrued tax and social security contribution obligations, including personal income tax and social security contributions of employees withheld at source; arrears on social entitlement benefits (apart from pensions) to households; arrears incurred with respect to the purchases of goods and services from suppliers; and arrears related to the servicing of domestic debt.

  • The outstanding stock of wage arrears at a particular date are defined as total accumulated unpaid wages of all employees on the regular payroll of all units belonging to the parts of the general government as defined above, up to the latest preceding regular pay date, which have not been settled by the test date. The total stocks of wage arrears, thus defined, are on a gross basis and are calculated by summing the wage arrears of all units of government with regard to their own employees; transfers between different levels of government for making wage or other payments are excluded from the estimates of these wage arrears.

  • Pension arrears are defined as total accumulated pensions due but not disbursed by the pension funds concerned to all pensioners in the pension rolls up to the latest preceding pension disbursement date.

  • The outstanding stocks of tax and social contribution arrears at a particular date comprise total accumulated accrued tax obligations of the parts of the general government as defined above that have not been paid by the test date. The total stocks of such arrears are on a gross basis and are calculated as the sum of such arrears.

  • Social entitlement payments, apart from pensions, are defined as all cash payments due directly to, or on behalf of, the population in accordance with stipulations in the law and which are not contingent upon the provision of any services or sale of any goods or assets to the general government by such members of the population in return for these payments. The stock of such entitlement arrears are defined as total accumulated payments due but not disbursed by all units of government up to the test date. Thus defined, these arrears are also on a gross basis and do not include the netting out of any transfers made between different units of the general government for the payment of such entitlements.

  • Arrears to suppliers comprise payments delayed beyond what was explicitly specified in relevant contracts, or in the absence of such specification, for two months from the date of submission of bills, for already-effected purchases of goods or services by the government concerned. These include, inter alia, arrears to utility companies, arrears incurred with respect to service and maintenance contracts, and payments not made for the purchase of goods and supplies such as equipment and furniture. These arrears are also defined on a gross basis and overdue tax and other obligations to the government of the relevant enterprises are not included in the calculation of the arrears of the government unless there is mutual agreement on the cancellation of debts. Netting out of any transfers made between different units of the general government for the payment of such arrears and obligations are also not taken into consideration.

  • Arrears to domestic banks and nonbank lenders comprise all overdue payments related to financial contracts between the government and domestic banks, nonbank financial institutions, nonfinancial institutions, and private lenders.

  • At end-December 2000, the stock of arrears of the Federal government was estimated at YUD 7.063 billion; and the stock of arrears of the consolidated general government in Serbia was estimated at YUD 32.522 billion.

  • DM denominated claims on government will be converted at the exchange rate of DM 1 = YUD 30; claims denominated in currencies other than the DM will first be converted at their respective exchange rates against the DM prevailing on December 31, 2000. The change in arrears is defined as the change in the end-period stock of arrears. Changes in wage and pension arrears will be adjusted for the changes in the average wage and average pension in the economy relative to their respective values in December 2000.

13. Reporting. Before the last business day of each month, data on end-period stocks of arrears for the previous month will be supplied to the European 1 Department of the Fund by the Federal Ministry of Finance, the Ministry of Finance of Serbia, and the Ministry of Finance of Montenegro.

E. Definition of Reserve Money

14. Definition. Reserve money is defined as the sum of currency in circulation (NBY Bulletin, September 2000, Table 3A, column 8) and reserves banks are required to hold under the standard reserve requirement, plus excess reserves of the commercial banks at the NBY. Shortfalls in reserves that banks are required to hold, will be included in required reserves (and therefore in reserve money), as well as in bank borrowing from the NBY. Reserves that banks are required to hold under the standard reserve requirement are currently set at 24.5 percent of the base as defined in the NBY Decision of September 24, 1999. Reserves that banks hold at the NBY to satisfy other additional or special reserve requirements will not be included as part of the amounts necessary to satisfy the standard reserve requirement. The amounts that banks are permitted to hold in securities to satisfy the statutory reserve requirement will be limited to the amount that banks were holding as of December 31, 2000 (YUD 174.1 million). Excess reserves include commercial bank balances in Giro accounts 620, 621, 623, and 625 with the NBY and cash in commercial bank vaults.

15. Data on reserve money will be monitored from the daily indicators data of the NBY, which shall be supplied to the European 1 Department of the Fund weekly by the NBY with a three-day lag. On December 31, 2000, currency in circulation amounted to YUD 10,933 million while required reserves amounted to YUD 4,824.0 million, and excess reserves to YUD 4,088 million. Data on effective reserve requirements and the deposit base used in reserve requirement calculations will be supplied to the European 1 Department within two days of the 11th, 18th, and 28th day of each month.

16. Adjusters. For program monitoring purposes, reserve money will be adjusted as follows: Should the standard reserve requirement increase (decrease) from the level prevailing on December 31, 2000, the ceiling on net domestic assets would be increased (decreased) by an amount equivalent to the change in the standard reserve requirement ratio multiplied by the programmed deposit base used in the calculation of required reserves. Before making any such changes, the NBY will consult with Fund staff. Required reserves of banks placed under BRA administration or liquidation will remain part of reserve money for program purposes.

F. Ceiling on External Debt-Service Arrears

17. Definition. External debt-service arrears are defined as overdue debt service arising in respect of obligations incurred directly or guaranteed by the public sector, except on debt subject to rescheduling or restructuring. The program requires that no new external arrears be accumulated at any time under the arrangement on public sector or public sector guaranteed debts.

18. Reporting. The accounting of nonreschedulable external arrears by creditor (if any), with detailed explanations, will be transmitted on a monthly basis, within two weeks of the end of each month. This accounting will include, separately, arrears owed by the Federal, Serbian and Montenegrin governments, and other public sector entities; arrears owed by Yugoslav Airlines; and arrears owed to Paris Club creditors, non-Paris club creditors, and other creditors. Data on other arrears, which are reschedulable, will be provided separately.

G. Ceilings on External Debt

19. Definitions. First, with regard to the ceiling on contracting or guaranteeing of new nonconcessional external debt by the public sector with original maturity of more than one year: 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 on August 24, 2000 (Decision No. 12274-(00/85), see attachment to this Annex) but also to commitments contracted or guaranteed for which value has not been received. Excluded from this performance criterion are loans from, or other indebtedness to, the EBRD, the EIB, the IBRD, the IMF, and the IFC. Concessionality will be based on a currency-specific discount rate based on the ten-year average of the OECD's commercial interest reference rate (CIRR) for loans or leases with maturities greater than 15 years and on the six-month average CIRR for loans and leases maturing in less than 15 years. Under this definition of concessionality, only debt with a grant element equivalent to 35 percent or more will be excluded from the debt limit. Second, with regard to the ceiling on new external debt with original maturity of up to and including one year owed by the consolidated general government or guaranteed by the public sector : 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 (Decision No. 12274-(00/85). Excluded from this performance criterion are short-term import credits.

20. Reporting. A debt-by-debt accounting of all new concessional and nonconcessional debt contracted or guaranteed by the public sector, including the original debt documentation, as well as all relevant supporting materials, will be transmitted on a quarterly basis within four weeks of the end of each quarter.

III. Other Reporting Requirement for Program Monitoring

A. Macroeconomic Monitoring Committee

21. A macroeconomic monitoring committee, composed of senior officials from the Federal Government, Serbian and Montenegrin Ministries of Finance, the NBY, and other relevant agencies, shall be responsible for monitoring the performance of the program, informing the Fund regularly about the progress of the program, and transmitting the supporting materials necessary for the evaluation of performance criteria and benchmarks.

B. Developments on Structural Performance Criteria and Benchmarks

22. The authorities will notify the European 1 Department of the Fund of developments on structural performance criteria and benchmarks as soon as they occur. The authorities will provide the documentation, according to the dates in Annex B, elaborating on policy implementation. The authorities will also notify the European 1 Department of the Fund of any economic developments or policy measures that could have a significant impact on the implementation of this program.

C. Data Reporting

Production and prices

23. The following information will be transmitted at the time of their publication:

  • The retail price index, the industrial price index, the industrial production index, wages and employment, and exports and imports.

24. Any revision to the national accounts data will be transmitted within three weeks of the date of the revision.

Public finance

25. Monthly data on public finance will require a consolidated budget report of the Federal and Republican governments comprising:

  • The revenue data by each major item, including that collected by the federal and the republican governments;

  • Details of the recurrent and capital expenditure of the federal and republican governments; and

  • Details of budget financing, domestic, and external data will be transmitted within four weeks of the end of each month.

Monetary sector data

26. The following data will be transmitted on a daily/weekly/biweekly basis within one/five working days of the end of each day/week.

  • Daily movements in gross foreign exchange reserves of the NBY at current exchange rates, indicating amounts sold/bought at the auction, purchases through ZOP, purchases on the interbank market, inflows of foreign grants, inflows of foreign loans, and repayments of frozen currency deposits.

  • Daily movements in foreign exchange denominated liabilities of the NBY to (i) non-residents; (ii) Yugoslav banks; and (iii) Yugoslav residents.

  • Daily movements in liquid foreign exchange assets of Yugoslav banks as reported by these banks to the NBY.

  • Daily movements in reserve money, indicating currency in circulation, the basis upon which required reserves are calculated, required reserves, reserves held, and excess reserves.

  • Treasury bill auction details (rates, amounts per maturity and number of banks participating in the auction per maturity); and

  • Interbank foreign exchange rates and volume of transactions.

  • Public sector borrowing and lending from commercial banks and the NBY.

27. The balance sheet of the NBY and the consolidated balance sheets of the commercial banks, including all banks in Montenegro, will be transmitted on a monthly basis within three weeks of the end of each month. The stocks of government and mandatory and voluntary NBY securities held by banks and by non-banks, as available to the NBY, detailed information on interbank money market transactions (terms, duration, and participating institutions), and interest rate developments will be transmitted on a monthly basis within two weeks of the end of each month.

External data

28. The data below will be transmitted as follows:

  • The interbank market exchange rate, as the simple average of the daily-weighted average buying and selling rates, will be transmitted on a weekly basis within five business days of the end of the week;

  • Balance of payments data on services, private transfers, and capital account transactions will be transmitted on a quarterly basis within four weeks of the end of each quarter; and

  • Detailed monthly data on the volume and prices exports and imports, including a separate report on imported petroleum products.


Executive Board Decision No. 6230-(79/140) (Guidelines on Performance Criteria
with Respect to Foreign Debt) adopted August 3, 1979, as amended by Executive
Board Decision No. 11096-(95/100) adopted October 25, 1995, and as amended on August 24, 2000

Point No. 9

(a) For the purpose of this guideline, the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:

    (i) loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);

    (ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and

    (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.

(b) Under the definition of debt set out in point 9(a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. However, arrears arising from the failure to make payment at the time of delivery of assets or services are not debt.