Bulgaria and the IMF |
Press Release: IMF Completes Third Review and Approves US$37 Million Disbursement Under Stand-By Arrangement for Bulgaria
July 8, 2003
Country's Policy Intentions Documents
of Intent and Supplementary Memorandum of Economic and Financial Policies
Sofia, Bulgaria, June 18, 2003
Mr. Horst Köhler
The attached Supplementary Memorandum of Economic Policies (SMEP) discusses our performance under the program supported by the Stand-By Arrangement (SBA) with the Fund and the policies that the government and the Bulgarian National Bank plan to implement during the remainder of 2003 and 2004. We remain committed to our policy objectives laid out in the Memorandum of Economic Policies (MEP) dated February 12, 2002 and updated in the SMEPs dated July 5, 2002 and January 22, 2003. In the context of our currency board arrangement, we will maintain macroeconomic stability, while working toward continued robust and sustainable growth to improve our people's living standards.
During the last six months, macroeconomic performance has been strong and, as indicated in the SMEP, program implementation was on track. As the third review was delayed for a few days into July, end-June performance criteria (PCs) are legally controlling for the purchase associated with this review. In this context, we request a waiver of applicability for all end-June performance criteria for which data are not yet available. We expect to observe all PCs. We propose to convert the indicative targets previously set for end-September and end-December 2003 into performance criteria.
In view of the above we request the completion of the third review under the SBA. In addition to analyzing economic policies and conditions in general, the fourth review will focus on measures to strengthen tax administration, expenditure management, and the budget process. We will continue to consult with the Fund on a regular basis regarding any additional measures that may become appropriate to ensure that program implementation remains on track.
Supplementary Memorandum of Economic Policies of
1. Bulgaria has made further progress toward sustained robust economic growth and higher living standards, which are key objectives of our economic program. To this end, we have continued to adhere to cautious fiscal and incomes policies in support of the currency board arrangement (CBA). We are carrying out our structural reform agenda to foster growth, while strengthening the social safety net, and taking steps to reduce long-term unemployment.
2. The implementation of our economic program--supported by a Stand-By Arrangement with the Fund--remains on track. All end-December 2002 and end-March 2003 performance criteria (PCs) and indicative targets were observed, with the exception of the indicative target on arrears to the electricity company (NEK), for which remedial measures have been taken (Tables 1a and 1b). On structural benchmarks, only the transfer of the remaining accounts into the Treasury Single Account has not been done owing to technical difficulties, but the government intends to complete this process by end-September 2003 (Table 2a and 2b).
B. Recent Economic Developments
3. After a strong performance in 2002, macroeconomic developments in the first quarter of 2003 have remained favorable, despite an unsettled external environment, including continued slow growth among Bulgaria's trade partners.
4. We met our 2002 fiscal deficit target and the execution of the 2003 budget has been significantly better than programmed. Last year, the deficit was limited to 0.6 percent of GDP and, in the first quarter of 2003, a surplus of 0.3 percent of annual GDP was recorded, compared to a projected deficit of 0.8 percent of GDP. Most of the overperformance in the first quarter was accounted for by better-than-projected revenue collection, in particular with regard to non-tax revenues. The registration of labor contracts and introduction of minimum insurable income thresholds has contributed to a significant rise in social security contributions, which were in line with program expectations. Spending was lower than budgeted as we proceeded cautiously with discretionary spending and some savings on external interest payments materialized. However, a sharp increase in the reimbursement of medicines by the National Health Insurance Fund (NHIF), delays in implementing reforms in the hospital sector, and the underfunding of mandated spending in the municipalities have resulted in spending overruns and arrears accumulation in these sectors, which we intend to address during the rest of the year.
5. We have continued to implement reforms that would keep our fiscal policy on a sound footing over the medium term. We have made progress in staffing and building the capacity of the National Revenue Agency (NRA) and strengthened the operations of the Large Taxpayer Office (LTO), meeting ahead of schedule the structural benchmark of raising the share of corporate tax revenue collected by the office to above 60 percent. We also tabled in parliament amendments to the municipal budget act to provide a measure of revenue autonomy to local government and clarify the scope of transfers from the central government.
6. Structural reforms have advanced, including with bank privatization and improvements in energy sector efficiency, but progress in some areas has proved more challenging. We have completed the sale of the last large government-owned commercial bank (DSK). We have continued to reform the railways sector, including by reducing loss-making activities, raising passenger tariffs toward cost-recovery levels, and lowering labor costs; and made significant progress in improving the efficiency of district heating. However, the privatization of the tobacco holding (Bulgartabac) ran into difficulties and would need to be relaunched, while the sale of the telecommunication company (BTC) is taking more time than initially envisaged. Reforms to improve the business climate and restructure the health sector have proved more difficult.
7. We have further strengthened banking supervision in light of the rapid growth in lending and taken measures to address the occasional large fluctuations in inter-bank overnight rates. In January, we introduced the new international accounting standards and more detailed bank reporting requirements, including for the currency composition of banks' balance sheets and income and expenses statements. We have maintained a proactive stance regarding supervision, with unscheduled bank inspections in response to signs of serious breaches of prudential norms, followed by mandatory remedial actions and an implementation timetable. In June, we implemented the real time gross settlements (RTGS) system, which will significantly improve the timeliness and security of bank transactions, while reducing occasional sharp fluctuations in interbank overnight interest rates. In this context, a small facility of 10 million leva financed by banks' contributions has been set up at the Bulgarian National Bank (BNB) for the purpose of smoothing temporary daily shortages in leva liquidity. In order to reduce volatility in overnight interest rates, a limited reverse repo facility (of up to 25 million leva) has been successfully introduced by the Ministry of Finance and the BNB has introduced same-day-value exchange of euros into levas by commercial banks.
C. Economic Policies for the Remainder of 2003 and 2004
8. With global uncertainty subsiding, we see our macroeconomic objectives for 2003 intact and medium-term prospects favorable. Having weathered the global tension at the beginning of the year with minimum fallout, our economy is expected to continue to grow as envisaged in our program, led by further gains in export markets and strong growth in investment. We expect inflation to remain subdued, reaching 4 percent at end-2003. The external current account deficit is projected to remain at about 4½ percent of GDP in 2003 and decline gradually over the medium-term. However, we are mindful that our external position could deteriorate if EU recovery in 2003 is slower than expected or if the rapid credit growth leads to an unexpectedly large import boom. We would adjust our policies to such circumstances.
Fiscal Policy and Public Sector Reforms
9. We believe our fiscal targets for 2003 and the medium term are fully achievable but stand ready to implement additional measures, as needed. The strong first quarter outcome and some additional revenue overperformance and interest savings projected for the remainder of the year provide sufficient cushion to meet the spending pressures that have emerged in the health and municipal sectors. In tandem with measures to stem these pressures, we intend to spend part of this overperformance of approximately 0.8 percent of GDP to cover the reimbursement of medicines and fully fund mandated spending by municipalities. In case the revenue overperformance were to exceed current projections for the remainder of the year, it would in part be saved--at least to the extent the overperformance is due to one-off factors--and the rest spent in the fourth quarter according to budget priorities. However, if the external current account deficit were to widen significantly relative to program expectations, spending would be kept in line with the original budget targets and, if necessary, the 88 percent rule continued through the fourth quarter.
10. We are taking steps to limit budget overruns and arrears accumulation in the health care sector and in municipalities. To deal with the immediate financial pressure arising from overruns in the repayment of medicines, the NHIF is taking administrative steps to increase the co-payment rate and better control the volume of prescriptions. Activities in a number of hospitals under the Ministry of Health are being rationalized. Looking at the longer haul, we are designing, in coordination with the World Bank, a broader hospital reform plan that would put the financial situation of the sector on a sound footing by gradually increasing the role of output indicators and the NHIF in hospital financing. As for municipalities, we intend to complete the broad reform agenda that was initiated last year. In this regard, we expect parliament to approve amendments to the municipal budget law by end-July. Clearance of municipal arrears will be limited to those related to the underfunding of mandated spending and the prompt payment of municipal obligations to public utilities will be strictly enforced.
11. We will continue to implement measures to improve tax administration. To make the NRA fully operational as soon as feasible, we will, by end-September, select an information technology system and initiate a pilot project in Bourgas (structural benchmark) and, by end-year, separate the collection function within the national social security institute (NSSI). We are taking steps to ensure that current efforts to strengthen revenue collection--notably the implementation of VAT accounts, the LTO, and the registration of labor contracts and minimum insurable income thresholds for social security contributions--are generating the results expected. To combat customs fraud, new counterfeit-proof banderoles for cigarettes and alcohol will be introduced, border point duty free shops will be closed except at airports, and the recommendations from the Crown Agents consultants implemented.
12. We are taking steps to enhance budgeting and expenditure management in the context of the preparation of the 2004 budget. We intend to bring the preparation process back in line with the new, accelerated schedule, and decide on the 2004 expenditure ceilings before the summer recess. Pilot program budgets for 2004 are under preparation in three ministries. The creation of a full-fledged Treasury Department and implementation by end-2003 of the Financial Management Information System at all second level spending units of the Ministry of Finance will strengthen budget execution significantly.
13. In line with our medium-term fiscal strategy, our goal remains to move to a balanced budget by 2005. In this context, we will continue to implement the tax policy plan adopted last year with a view to reducing the overall tax burden, shifting from direct to indirect taxation, and maintaining a broad tax base. More specifically, we aim to reduce the corporate tax rate to 20 percent in 2004 and 15 percent in 2005. Assuming continued good collection performance by the NSSI, we will consider reducing the social security tax rate. On the expenditure side, we intend to raise social spending and to expand the public investment budget in 2004--to absorb an increase in EU-financed projects while limiting crowding out of other projects. In order to create room for tax cuts and additional social and EU accession-related spending, we will step up our efforts to improve tax administration, curtail government subsidies--including for railways, district heating and hospitals--and improve the efficiency of government spending overall.
Labor Market and Other Structural Reforms
14. To maintain competitiveness and further lower unemployment, we will continue efforts to reform the labor code and strengthen active labor market policies (ALMPs). We will foster dialogue among social partners on the proposed labor code amendments to reduce hiring and firing costs. We will continue to help long-term unemployed regain their footing in the labor market through our program "From Social Assistance to Employment" and ensure that labor contracts are formally registered. We are committed to monitor and evaluate closely the efficiency and effectiveness of ALMPs and adjust these as appropriate.
15. We will advance privatization and expedite reforms in the energy and railways sectors. We will seek to complete the privatization of Bulgartabac and BTC in a fully transparent manner as quickly as possible. In addition, we will carry on with the preparations for the sale of electricity distribution companies. To facilitate this process and provide a modern institutional and legal framework to the energy sector in Bulgaria, we intend to have the draft energy law passed in parliament by end-June. Technical and administrative changes that are improving the efficiency of the district heating system are continuing and we expect to virtually eliminate the need for government subsidies next year. As for the railways, we will aim to create separate units for freight and passenger transport by end-July 2003 and reach our objectives of 10 percent reduction in personnel compared to 2001 and raising intercity passenger tariffs to 70 percent of cost-recovery levels by end-2003. Further, we are in the process of costing individual services, which will serve as a basis for signing public sector obligation contracts with the government in the context of the 2005 budget.
16. We will push for further legal and institutional reforms to enhance the business climate. With the assistance of the EU, World Bank, and others, we will step up the reform of the judiciary and take further steps to improve governance. To help attract more investment, we will continue to reform licensing, permit, and registration regimes and reduce their number. In this context, the draft licensing law, expected to be adopted by parliament by end-July, is intended to limit the government's discretion in introducing new license and permit requirements. The draft amendments to the commercial code expected to be passed by end-July will simplify bankruptcy procedures.
Financial and External Sectors' Policies
17. In the face of still-strong private sector credit growth, we will continue to strengthen the supervision of the banking system. We will continue our policy of conducting unscheduled inspections of any troubled bank followed by mandatory remedial actions. To minimize risks associated with rapidly increasing foreign currency lending, we will monitor closely the foreign currency exposure of banks and urge them to properly hedge against such risks. At the same time, with IMF technical assistance, we will determine the appropriate approach to monitoring the foreign currency-related credit risk arising from banks' fast growing lending in foreign currency to the corporate sector. In this context, the expected passage of amendments to the foreign currency law that would require companies to provide information on their foreign assets to the BNB would--along with the already compiled data on companies' foreign liabilities--help assess their foreign currency exposure.
18. The proposed government-sponsored private equity fund will be established with a government contribution not exceeding 100 million leva throughout the fund's life and with appropriate safeguards. We continue to view the establishment of this fund as important to increase equity financing in the private sector, and are moving to select among the short-listed bidders fund managers. We will, at launch, limit government participation to no more than 49 percent of committed funds, with the intention to reduce this participation over time. We will closely monitor the fund's performance. Further, we will establish other firewalls to help ensure that investment decisions are made without government involvement, including the requirement for the government to be a minority shareholder.
19. We will carry on with our active public debt management, with a view to continuing to reduce external vulnerability. Our objectives in this regard remain to achieve a more balanced interest and currency composition of the debt and increase the share of domestic debt, while continuing to lower the public debt-to-GDP ratio over the medium term. In addition, as opportunities present themselves, we will conduct specific debt operations, consistent with our strategy. We are also undertaking a more active management of the deposits in the fiscal reserve account (FRA). In this connection, the BNB has signed an agreement with the World Bank on behalf of the government to manage euro 75 million, according to pre-agreed investment guidelines.
Data Quality Issues
20. We plan to subscribe to the special data dissemination standards (SDDS) by year end, as we are making progress in observing standards and codes, while implementing the remaining safeguard recommendations. The assessment of the review of standards and codes (ROCS) mission in January concluded that we complied with the majority of standards and codes and we are taking steps to move to standards in those areas that were identified to require additional work. In this regard, we plan to disseminate the international reserves and foreign currency liquidity templates by end-2003. We are also making progress in implementing the remaining safeguard assessment recommendations, in particular preparing the audit procedure manual of the BNB.
The general government accounts are defined to comprise the consolidated budget (including the republican budget, the budgets of ministries and local governments, and the social security fund) as well as all extrabudgetary funds and accounts both at the central and local government levels.
The quarterly limits will be cumulative and will be monitored from the financing side as the sum of net credit from the banking system to the general government, including deposits and accounts abroad, net nonbank credit to the general government, privatization receipts of the budget, and receipts from external loans for direct budgetary support minus amortization paid. For calculating the performance against this ceiling, privatization receipts include the dividends the Bank Consolidation Company (BCC) distributed to the general government and taxes collected from BCC related to the sale of assets, and all the proceeds from the sale of GSM licenses. External drawings and repayments will be converted into leva at the BNB daily exchange rate. Valuation changes in deposits and accounts that are denominated in foreign currencies will be recorded daily and reported by the BNB and the Ministry of Finance at the end of each quarter, and such changes will be netted out.
The Fiscal Reserve Account (FRA) consists of (1) the balances in leva and in foreign exchange of the following accounts: all budgetary and deposit accounts in the banking system, including the central budget, ministries and agencies, central government extrabudgetary funds as defined in Annex No. 7 of the 2003 Budget Law, the National Social Security Institute, and the Health Insurance Fund, and (2) other highly liquid foreign assets of the central government.
The following assets qualify as highly liquid foreign assets:
(i) Foreign currency deposits with foreign financial institutions (or their branches) assigned a rating of AA- or higher;
(ii) Fixed income instruments issued by supranationals and foreign sovereigns (including financial institutions) that have a rating of AA- or higher, taken at market value;
(iii) Bulgarian Brady bonds and Eurobonds (acquired as treasury stock through market transactions) taken at 95 percent of market value.
In addition, the fixed income instruments (other than the Bulgarian Brady and Eurobonds) liquidity-wise have to satisfy the following conditions:
Finally, the modified duration of the entire portfolio of highly liquid assets should not be more than 4.5 years.
The limits will be monitored from the accounts of the banking system and marked-to-market data of other highly liquid foreign assets of the central government, to be provided monthly by the BNB and the Ministry of Finance. For the purposes of the program, deposit accounts and assets that are denominated in foreign currencies will be converted into leva at the December 31, 2002 exchange rates (1.88496 leva, and 0.73555 SDR per US dollar).
The Ministry of Finance will publish information on the level and composition of the FRA on the Ministry's website on a monthly basis. The information will include the overall balance of the FRA, the balance of the government deposit at the Bulgarian National Bank, and the total amount of foreign exchange denominated assets, including the highly liquid foreign assets.
The ceiling on the aggregate wage bill of the 60 state-owned enterprises closely monitored for their large losses or arrears, for receiving subsidies, or for being monopolies, is two percent above the level of their aggregate wage bill in the third quarter of 2002. The wage bill is defined to include wages and payroll taxes paid by the employer.
Those enterprises that have been privatized or ceased operations will be excluded from the list for the respective test dates. Those enterprises that register profits in each of the first two quarters of 2003 will also exit the list in the second half of 2003 unless they are monopolies, have arrears, or receive state subsidies. If an enterprise is excluded from the list, the wage bill ceiling will be adjusted down by the amount of that enterprise's wage bill in the third quarter of 2002 plus 2 percent. The 60 enterprises monitored (enterprises number 1 to 17 are considered monopolies):
These performance criteria are on the sum of changes in monitored arrears to the GTD and arrears to the NSSI. For the purpose of these performance criteria, arrears are defined to include interest and penalties. The enterprises monitored for arrears to the GTD:
The enterprises monitored for arrears to the NSSI:
For the purpose of assessing compliance with these performance criteria:
Other Performance Criteria1
1. The BNB will ensure that gross foreign reserves of the issue department are at least equal to the issue department's liabilities at all times. Issue department liabilities will comprise leva notes and coins in circulation, and deposits from the banking department, banks, government, and the nonfinancial sector with the BNB, excluding liabilities to the IMF. For the purpose of this performance criterion, issue department liabilities will be converted into foreign exchange using the official exchange rate. The BNB will exclude placements from other agencies under fund management contracts from the balance sheet of the issue department.
2. The BNB shall not increase credit to the government at any time during the period of the CBA, except as allowed under the Law of the BNB, nor shall it purchase Bulgarian government securities.