Press Release: IMF Approves US$34 Million Under Stand-By Credit for Bosnia and Herzegovina
June 6, 2003

Bosnia and Herzegovina and the IMF


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Bosnia and HerzegovinaLetter of Intent, Supplementary Memorandum of Economic and Financial Policies, and Supplementary Technical Memorandum of Understanding
Sarajevo and Banja Luka, Bosnia and Herzegovina
April 24, 2003


The following item is a Letter of Intent of the government of Bosnia and Herzegovina, which describes the policies that Bosnia and Herzegovina intend to implement in the context of its request for financial support from the IMF. The document, which is the property of Bosnia and Herzegovina, 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
Washington, D.C. 20431

Dear Mr. Köhler:

The new governments that have formed at the State and Entity levels following the October 5 elections acknowledge the achievements made by its predecessors during the initial phase of the IMF-supported program. Moreover, we fully endorse the goals and commitments of the economic program. In particular, we are committed to promote sustained economic growth and improved living standards through continued macroeconomic stability and further implementation of structural reforms necessary to create a fully-functioning market economy and enhance competitiveness. In this context, we strongly back the maintenance of the currency board arrangement, further fiscal consolidation, and continued structural reforms. In support of this program, we are requesting completion of the second and third reviews under the Stand-By arrangement (SBA).

The attached Supplementary Memorandum of Economic Policies assesses economic developments and policy implementation through December 2002 under the program, and lays out the concrete policy measures to be taken during 2003.

As noted in the attached memorandum, overall policy implementation through December 2002 has been strong, but some policy objectives were not realized. While we regret that two performance criteria and one structural benchmark for end-December 2002 were not observed, we are pleased to note that corrective action has been taken. Accordingly, we are confident that the difficulties will not recur and that all the end-March 2003 performance criteria will be fully adhered to. As the board date for the second review takes place after March 31, we understand that it is the end-March performance criteria, rather than the end-December performance criteria which are controlling.

We expect the fourth review under the arrangement to be conducted with the Fund as scheduled after mid-August 2003. It will focus on the rebalanced budgets for 2003 of the Entity and State governments, and initiatives to translate the substantial medium-term reform agenda into concrete measures. Both will be implemented by our new administrations during the remainder of the program and in the framework of a possible successor extended arrangement to the SBA.

We believe that the policies described in the memorandum are adequate to achieve the objectives of our economic program, but we stand ready to take additional measures to meet these goals should the need arise. During the period of the arrangement, we will consult with the Fund on the adoption of any such measures that may be necessary in accordance with the Fund's rules on such consultations and we will provide the Fund with any information it requests for monitoring progress in program implementation.

We are committed to transparency in our economic policies, and we authorize the Fund to publish this letter and the SMEFP following Executive Board consideration of the second ant third reviews under the Stand-By Arrangement.

Sincerely yours

/s/
Adnan Terzic
Chair of the
Council of Ministers
Bosnia and Herzegovina
    /s/
Ahmet Hadzipasic
Prime Minister
Federation of Bosnia
and Herzegovina
     
/s/
Dragan Mikerevic
Prime Minister and
Acting Minister of Finance
Republika Srpska
  /s/
Ms. Ljerka Maric
Minister of Finance
of BiH Institutions
Bosnia and Herzegovina
     
/s/
Dragan Vrankic
Minister of Finance
Federation of Bosnia
and Herzegovina
  /s/
Peter Nicholl
Governor
Central Bank of
Bosnia and Herzegovina


Supplementary Memorandum of Economic and
Financial Policies For Bosnia and Herzegovina

1. We begin our terms of office at a critical time. Though output is growing, the post conflict-boom is clearly over, activity remains well below pre-war levels, refugees from abroad continue to return in large numbers, and unemployment and the external current account deficit remain unsustainably high. Furthermore, the reconstruction phase of Bosnia's development is well advanced and our nation's focus is shifting increasingly towards preparations for eventual accession to the European Union. In the four year term allotted to us, much needs to be done to address these challenges.

2. Our economic program, as supported by the Stand-By Arrangement, is the foundation of our efforts to respond to these challenges. We endorse the program's goals, its three central elements—the currency board arrangement, fiscal consolidation, and structural reforms—and the specific commitments incorporated in it as reflected in the two earlier Memoranda of Economic and Financial Policies. We will act as necessary to secure its completion and on that basis, we look forward to negotiations for a successor arrangement.

3. Much has been achieved under the program so far:

  • The currency board has strengthened. Reserves rose from three to five months of import cover in the six months to end-2001, and at end 2002, they still provide 4.7 months of imports and more than cover base money.

  • The consolidated fiscal deficit was reduced from 5.8 percent of GDP in 2001 to 4.3 percent in 2002. This was faster progress than envisaged under the program and occurred despite the heavy one-off costs of military demobilization in both Entities. Also ahead of program commitments, 0.3 percent of GDP of succession monies used in the demobilizations has been reconstituted. Pensions, social benefits, and government wages have been regularly paid on time and in full, ending the hitherto frequent accrual of arrears in these areas. Strengthened tax administration and effective treasury control were key to these successes.

  • Succession and privatization receipts have been put in escrow in anticipation of a restructuring of domestic claims on government and efforts to quantify the claims are making good progress.

  • Both Entities and the State approved budgets for 2003 which anticipate a consolidated fiscal deficit target of 2.2 percent of GDP in 2003. We supported those budgets in our legislatures before assuming office.

  • Fiscal structural reforms have advanced. All structural benchmarks concerning indirect taxation have been observed following implementation by Brcko District of the road fee effective January 1 2003, the excise attribution mechanism is now working, and the ASYCUDA++ customs information system is in place nationwide. Treasury systems operate at central governments and have begun operations in two Canton so far. In addition, free trade agreements have been concluded with our neighbors, and WTO accession is anticipated in 2004.

  • In December 2002, consistent with the currency board arrangement and international accounting standards, the Central Bank assumed responsibility to act as fiscal agent for Bosnia and Herzegovina vis—vis the IMF, taking this task over from the State Ministry of the Treasury. Good progress has been made in implementing the recommendations of the IMF safeguards assessment report, notably by strengthening the financial reporting framework, the internal audit mechanism, and internal control mechanisms at the Central Bank.

  • Industrial production has reportedly strengthened following the end-2001 trough, led by manufacturing. After falling 20 percent in 2001, RS manufacturing output rose 4 percent in 2002, while in the Federation, manufacturing production rose by 13¼ percent in 2002, a little below its growth in 2001. In both Entities, a strong increasing trend is indicated in the latter part of 2002.

4. As a result, we have inherited a policy framework that is in good shape. But it is not without problems:

  • Bank credit to the private sector has expanded rapidly in 2002, boosting imports and the external current account deficit. Though this originates in deposit growth which reflects a welcome strengthening in confidence in the KM and in banks, the consequent credit expansion has increased external pressures and raises some prudential concerns. Both need to be addressed.

  • Though the RS budget deficit outturn was stronger than anticipated in the rebalanced 2002 budget, both performance criteria ceilings on gross borrowing from domestic banks were exceeded at end-December 2002 by modest amounts. The breach for central government reflected temporary (two week) bank borrowing by the Roads Directorate, while the breach for the extra budgetary funds occurred largely because the planned transfers of debt from the funds to the central government was not executed in time.

  • Monitoring of fiscal developments in cantons remains inadequate, and cantons may have overshot their programmed deficit for 2002.

  • The structural benchmark requiring application of banking regulations was breached in two areas. First, the minimum capital requirement of KM 15 million, effective January 1, 2003, was not met by 7 of 30 banks in the Federation and by 2 of 10 banks in the RS. Second, many banks have not observed the foreign exchange exposure regulations. Furthermore, some key banking regulations do not conform with international standards, notably in respect of core capital, capital for market risk, and consolidated banking supervision, and the regulation defining limits on foreign exchange exposures is insufficiently comprehensive.

  • Though indirect tax legislation has been harmonized, there are risks of further disharmonization in the legislation and implementation of these taxes arising from the fact that they are legislated at Entity and Brcko District level. Furthermore, there are indications of evasion of customs and sales tax duties.

  • The reserve requirement regulations of the central bank do not apply to foreign currency liabilities of banks. This is discriminatory and disadvantages the KM inappropriately.

  • A bilateral agreement with Japan to reschedule official debt in accordance with the 1998 Paris Club agreement has not yet been reached.

5. Furthermore, major challenges lie ahead in the immediate future. In 2003, Bosnia and Herzegovina faces the deceleration of economic growth in Europe which will dent our export prospects there as well as the inflow of remittances from that region. In addition, international oil prices have sharply increased. With economic growth, employment, and exports already too low, these external factors will aggravate our underlying difficulties in the near term. And tensions in the middle east raise risks of shocks to capital flows emanating from that region and elsewhere to finance the external current account deficit.

6. In this context, we feel it necessary to act decisively and promptly.

7. Our first action has been to clarify our policy commitments. We have made clear in public that:

  • We are committed to eventual EU accession.

  • We are committed to the continued operation of the currency board.

  • We are committed to continue the strong fiscal consolidation that was delivered by our predecessors and which is anticipated to continue under the IMF supported program.

  • We are committed to implementing a range of structural reforms which will unlock the productive potential of the people of Bosnia and Herzegovina, while also securing their social needs as those reforms are implemented.

  • We are committed to pursuing these goals, supported by the Stand-By Arrangement.

These commitments confirm our determination to maintain the exchange rate regime which has secured low inflation, to fiscal policies which will place downward pressure on the external deficit while releasing resources to finance new fixed investment, and to structural reforms which will support the currency board while boosting prospects for economic growth. Our strong reaffirmation of these principles is aimed to reassure our citizens and markets that policies will remain on track, notwithstanding short-term adverse external developments.

8. Second, we have prepared and taken concrete steps to address the immediate shortfalls in the inherited policy framework.

  • We feel it necessary to ensure that the growth of credit slows, and that related prudential concerns in banks are addressed. To this end, we will amend the central bank law to implement the following reforms, which will be prior actions for completion of the second and third reviews.

    • We will amend the definition of assets eligible to meet reserve requirements to exclude cash in vaults. KM assets held with the Central Bank will be the only assets eligible as required reserves.

    • Relatedly, we will incorporate foreign currency deposits and foreign liabilities in the base for calculating reserve requirements of banks, and this has been announced.

    • We will amend the range which limits the reserve requirement ratio from 10-20 percent, to 0-20 percent.

    We will seek to implement these amendments under urgent parliamentary procedures and we will lower the applied rate of reserve requirement in consultation with IMF staff. Any subsequent change in the rate will be done in consultation with IMF staff, for the duration of the program.

  • We are concerned that the prospective deceleration of credit to the private sector has not been sufficiently reflected in the revenue estimates in the 2003 budgets. We propose to maintain spending authorizations below budgeted levels and will, each quarter, determine these authorizations in consultation with IMF staff, so as to ensure that spending remains at least KM 75 million (0.7 percent of GDP) below the budgeted level, with this sum split 2/3:1/3 between the Federation and RS, respectively.

  • Arrangements have been announced for an orderly transition from the current governing board of the central bank to the new board, given that the terms of the incumbents end in August this year. The new governing board will be nominated by April 2003 and will be composed of appropriately qualified individuals committed to the currency board.

  • We have taken several corrective actions in the RS to avoid a recurrence of the slippages which marred fiscal performance at end-December.

      (a) The Roads Directorate has already repaid its loan.

      (b) We have transferred loans from the extra budgetary funds to the central government, lowing their borrowing towards the end-March ceiling.

      (c) We have issued a decree, valid for six months and renewable, effective February 18, 2003, which bars all central government institutions, extra budgetary funds, and municipalities from new bank borrowing, unless in the latter case, borrowing occurs under IBRD programs. The decree also requires municipalities to report monthly to the Ministry of Finance on the stock of outstanding borrowing. Any amendments to the decree will be made following agreement with staff of the IMF. The decree anticipates new regulations for this borrowing, and they will require prior approval by the Minister of Finance for all borrowing by central government institutions, extra budgetary funds, and municipalities.

      (d) We have confirmed that the housing fund will conduct all its activities using commercial banks as intermediaries.

      (e) We have initiated procedures to reconcile central bank and government data on central government and extra budgetary fund borrowing from banks each month in order to strengthen surveillance of these matters.

      (f) Stronger-than-budgeted contribution receipts will allow a lower-than-budgeted transfer to the pension fund in the first quarter and this saving will allow a reduction in government bank borrowing to within the end-March ceiling.

  • We have established a commission to prepare a reform of the framework of indirect tax and customs legislation and administration. This framework will anticipate unification of the customs administrations and a single state level VAT. It will secure a professional tax administration, support macroeconomic stability, and tie decision-making on indirect tax policy closely to responsibility for expenditure policy. The commission has begun its deliberations and will complete its work on the framework before mid-year. Completion of these framework tasks will be a structural benchmark under the program. Once those tasks are completed, the commission will turn its attention to preparation of a VAT law.

  • We have reopened discussions with the Japanese authorities on the outstanding issues on the bilateral rescheduling agreement under the 1998 Paris Club agreement.

  • We have initiated steps to obtain an international credit rating.

9. Further actions are anticipated.

  • We will amend by end-June 2003 our regulations on banks' foreign currency exposures to include assets and liabilities indexed to foreign currencies and this amendment will be considered as a structural performance criterion. In addition, as a prior action for completion of the second and third reviews, we will collect all bank by bank data on foreign currency exposure including all indexation by mid-March, 2003. We will require all banks to conform with the newly defined regulation after a phase-in period, the length of which will be determined in consultation with IMF staff before promulgation of the new regulation.

  • As a prior action for the completion of the second and third reviews, all banks that fail to meet the minimum capital requirement of KM 15 million will have their licenses withdrawn, or will be placed under administration, unless they are engaged in a restructuring program under the auspices of the International Financial Institutions. Thus, the legal exemptions to this requirement will be revoked; and banks under administration will not be brought out of administration until they have met the KM 15 million requirement.

  • We will amend our regulations on banks' core capital to bring them into line with Basel core principles and EU standards, subject to a phase in period of 9 months after the regulations take effect. These amendments will be considered as prior actions for completion of the second and third reviews.

  • Our banking agencies will take the corrective actions specified in law and in the regulations when banks do not conform to banking regulations.

  • We will engage in a dialogue with IMF staff concerning banking regulations on market risk and consolidated supervision. This discussion will aim to identify appropriate changes in our regulations in these areas to bring them into line with international standards.

  • Efforts to strengthen further the strong safeguards in the Central Bank will continue focusing on completing our assessment of the risks in each of the operations of the Bank

10. Third, we remain committed to the principles for rebalancing the 2003 budgets that were outlined in the first review of the program. In particular, we intend to maintain the revenue projections as currently embedded in the 2003 budgets—supported by the additional measures described above—and limit overall budgeted government spending to the amount specified in the 2003 budgets, while offsetting any possible increases in spending by one level or sector of government through commensurate expenditure cuts in other parts of the government. All adjustments to the 2003 fiscal framework will be undertaken in consultation with IMF staff. If bank credit growth remains excessive and tax revenues are accordingly above our projections, we will assign the revenue overperformance to further deficit reduction. And if the external current account balance does not strengthen appropriately, we stand ready to take further policy measures as needed, including further fiscal consolidation. In any event, we will fully reconstitute during 2003 all succession money used to finance the 2002 demobilization programs and will continue to place all privatization receipts into escrow accounts and only make withdrawals from those accounts following prior consultation with IMF staff.

11. We recognize the need to strike a balance between the social needs of the population and the maintenance of a sound fiscal stance. In this light, we will:

  • review expenditure policies for war veterans, with the objective to at least maintain the level of benefits for those in most need, while seeking to reduce misuse of these benefits.

  • review the much-abused provisions allowing war invalids to import vehicles duty-free and take steps to strengthen the administration.

  • allocate higher than programmed pension contribution collections in the RS, and the benefits of structural reforms on the spending side, between reductions in central government transfers to the pension fund and increased average pensions.

12. We will continue to strengthen fiscal operations at local government levels.

  • In the Federation, we will ensure that all own-revenue users in the cantons, including universities, education, and health facilities, will be part of the cantonal treasury systems, and the central government will issue a decree to this effect by the end of March.

  • Monitoring and coordination of cantonal fiscal activities will be strengthened through

    (a) establishing a committee of all canton Ministers of Finance and the Federation Minister of Finance to meet monthly to review cantonal fiscal issues.

    (b) strengthening data reporting by means of a of template agreed with Fund staff, to be completed monthly, with a four week lag, commencing immediately. The data will be promptly forwarded to Fund staff.

  • In the RS, we have begun preparations for establishing treasury systems in 5 municipalities, with the objective to have the treasury systems operational in these municipalities by end-September 2003.

13. In anticipation of a plan to restructure domestic claims on government by mid-2003 we have, with FAD assistance, initiated the establishment of individual-by-individual databases on outstanding expenditure arrears at entity central governments and at the larger cantons. We will continue the quantification of potential war claims and our audit institutions will scrutinize identified spending arrears. Moreover, in consultation with IMF staff, we will prepare proposals for the restructuring and clearance of the identified claims using the privatization and succession monies which have been put in escrow for this purpose.

14. In the context of the adverse external trends and our proposed policy responses to them described above, we anticipate GDP growth of 3¼ percent (3¾ percent in the Federation and 1¾ percent in the RS) and inflation below 1 percent in 2003, alongside a strengthening in the external current account deficit of 3-4 percentage points of GDP. This is consistent with a decline in projected external debt to 46 percent of GDP.

15. These initiatives mark only part of our initial efforts. In addition, we will deepen structural policy reforms. These reforms aim to stimulate economic growth and employment, while reducing the external current account imbalance and supporting the currency board.

  • Following passage of the bankruptcy law in 2002, the first bankruptcies in the RS are anticipated from March 2003. Application of the law will not be postponed. The draft amendments to the Federation bankruptcy law will be submitted to parliament by end-April.

  • Privatization slowed in 2002 and needs to be revived. The recent RS legislation requiring RSNA approval of major privatizations as well as supermajorities in company boards to approve capital increases may be impeding progress and will be reviewed as a matter of priority. In the Federation, efforts will focus on strengthening the independence and managerial capacity of the privatization agency.

  • The business environment is strengthening under the auspices of the World Bank BEAC. The blueprint for the collateral registry system will be completed by end-March in preparation for a full launch a year later, and initiatives to lower the time taken for business registration will continue.

  • Efforts to strengthen the legal system are well underway. The numbers of judicial posts and courts are being lowered, and all judges are subject to reappointment to ensure their competence and integrity.

16. All these efforts will need to be considerably deepened to entrench a single economic space and to create the conditions for sustained economic growth. We will liaise closely with the donor agencies involved to determine how best to develop these initiatives further. In particular, we will investigate as a matter of priority how to improve the management of state-owned companies while they remain in state hands, how to increase the flexibility of wage setting arrangements, and how to strengthen the operation of privatization investment funds. Design and implementation of these reforms will form the focus for the fourth review of the program.

17. On this basis, we request conversion of the indicative targets into performance criteria for end-June as set out in Table 1. As the board date for the second and third reviews takes place after March 31, we understand that it is the end-March performance criteria, rather than the end-December performance criteria which are controlling.

Table 1. Bosnia and Herzegovina: Quantitative and Structural Performance Criteria
Under the 2002–2003 Stand-by Arrangement

(In millions of KM, unless otherwise noted)
2002
2003
End-Dec.
Prog. 1 Est.
February Est.
End-March Prog.1 End-June2 End-September3

A. Quantitative performance criteria
Ceiling on gross credit of the banking system to the consolidated general government
  the State government4 0     0          0            0       0          
  the RS government and municipalities 10     14  10          10            10       10          
  the RS extra-budgetary funds 2     2          2            2       2          
  the Federation government 20     11  18          20            20       20          
  the Federation cantons 10     10  8          10            10       10          
  the Federation municipalities 8     4          8            8       8          
  the Federation extra-budgetary funds 0     0          0            0       0          
Ceiling on contracting or guaranteeing of new concessional external debt with original maturity of more than one year by the public sector5,6 445     187  . . .          445           

445      

445          

Ceiling on contracting or guaranteeing of new non-concessional external debt by the general government5,6 0     . . .         

0           

0      

0          

Ceiling on contracting or guaranteeing of new external debtby the general government with an original maturity of up to and including one year4 0 . . .         

0

0

0          

Ceiling on the outstanding stock of external payments arrears7 0 . . .         

0

0

0          

B. Structural Performance Criteria
  Continued adherence of the Currency Board Arrangement as constituted under the law, incorporating the amendments described in paragraph 10 of the MEFP (EBS/02/91, 5/30/02), and paragraph 24 of the SMEFP (EBS/02/203, 12/4/02).

Met 

Met        

  Amend regulations on banks' foreign currency exposures by end-June 2003 to include assets and liabilities indexed to foreign currencies.

Sources: BIH Authorities; and IMF staff estimates.
1Targets for end-December 2002 and end-March 2003 are performance criteria.
2Targets are proposed as performance criteria.
3Targets are indicative.
4Excluding letters of credit at the state level for CIPS financing up to KM 40 million. Actual borrowing for CIPS was KM 8 million at end-December 2002.
5New refers to all operations taking place after August 2, 2002.
6The public sector is defined as general government and public enterprises.
7This will apply on a continuous basis.


Table 2. Bosnia and Herzegovina: Revised Structural Benchmarks,
September 2002–June 2003

Implementation Date

Lead Institution


I.  Prior Actions
1.  Banking regulations will be brought in line with Basle Core Principles and European directives in regard to core capital requirements, as specified in paragraph 9 of the Supplementary Memorandum of Economic and Financial Policies (SMEFP). IMF
2.  All banks that fail to meet the minimum capital requirement of KM 15 million will have their licenses withdrawn or will be placed under administration, unless they are engaged in a restructuring program under the auspices of the International Financial Institutions, as specified in paragraph 9 of the SMEFP. IMF
3.  Collect all bank by bank data on foreign currency exposure, including assets and liabilities indexed to foreign currencies, as specified in paragraph 9 of the SMEFP. IMF
4.  Amend definitions of assets eligible to meet reserve requirements to exclude cash in vaults, include foreign currency deposits and foreign liabilities in the base for reserve requirements, and expand the permissible range for reserve requirements to 0-20 percent, as specified in paragraph 8 of the SMEFP. IMF
II.  Structural Benchmarks
1.  The Entities will make transfers to the State, at least according to the agreed cumulative monthly schedule reported in Annex 1 of the MEFP. continuous IMF
2.  All privatization receipts accruing to the central governments of the RS and the Federation, and to the Cantons in the Federation will be placed in escrow accounts alongside all succession monies pending a comprehensive strategy to clear arrears. continuous IMF
3.  The Entities and the Brcko District will implement laws establishing the excise attribution mechanism as previously agreed with the World Bank and thereby avoid the double taxation on excises. continuous World Bank
4.  There will be no new free trade zones. continuous IMF
5.  Any changes to the current indirect tax system should retain or strengthen the principle of harmonization. continuous IMF
6.  The Federation pension fund will adhere to the cut-off dates for contribution collections at the end of each month as specified in the 2000 pension law. The RS pension fund will adhere to the cut-off date of the 10th of each month for contributions collec continuous IMF
7.  (a) The base of the Brcko District sales tax will remain aligned with that in the Entities. continuous IMF
  (b) The two rates of sales tax in the Brcko District will be 8 and 18 percent unless changes are agreed with IMF staff. continuous IMF
8.  A comprehensive strategy to clear arrears will be prepared. All arrears, including frozen foreign currency deposits, will be audited by the Supreme Auditor Institutions. End-June-2003 IMF
9.  Bosnia and Herzegovina will not clear domestic government payment arrears that were accrued before end-2000, pending a comprehensive strategy to clear arrears. continuous IMF
10.  There will be no offset operations for tax liabilities that are incurred after 2001. continuous IMF
11.  Banking supervision will be strengthened by enforcing the current prudential regulations, by taking appropriate remedial actions according to the regulations in cases where institutions breach regulations. continuous IMF/World Bank
12.  The commission on Value Added and Customs Administration will propose a framework of legislation governing all indirect tax legislation and administration. End-June 2003


ANNEX I

Pursuant to Chapter II, Article 7, Point 1 of the Law on Foreign Debt and Article 14, Point b of the Treasury Law, and in the context of the second review of the program supported by a Stand-By Arrangement from the IMF, the entity Ministers of Finance and the Minister of the Treasury of the BiH Institutions have reached the followings

AGREEMENT ON THE TIME SCHEDULE FOR THE PAYMENT

OF RESPECTIVE AMOUNTS FOR FOREIGN DEBT SERVICING

AND ENTITY CONTRIBUTIONS FOR THE ADMINISTRATIVE

SEGMENT OF THE 2003 BUDGET OF THE BiH INSTITUTIONS

I

In order to ensure timely payment of foreign liabilities and 2003 liability projections arising from foreign debt, in a total amount of KM 324.4 million, out of which KM204.3 milion is the Federation liability and KM 120 million is the Republika Srpska liability,

The Federation of Bosnia and Herzegovina and the Republika Srpska shall pay the required amounts against each due liability, 5 days ahead of the respective maturity date.

II

Total transfers in 2003 for the administrative segment of the budget of the BiH institutions amount to KM 87 million out of which KM 58 million is to be paid by the Federation and KM 29 million is to be paid by the Republika Srpska.

The transfer to the budget of the BiH institutions shall be paid on a monthly basis, ensuring that 1/12 (one twelfth) of the total transfer shall be remitted for every current month. Payments will be made at the latest by the 20th of each month for the liability of the previous month. All payments made after this day shall be considered arrears. The parties will agree on a timeframe for the full payments of obligations dating from 2001 and 2002.

III

By the 15th day of each month, the Minister of the Treasury of the BiH Institutions will provide a written report to the IMF indicating developments in transfers from the Entities to the State for administrative and debt service purposes during the previous month, noting their consistency with the commitments made in this agreement.

In Sarajevo, April 24, 2003.

/s/
Ljerka Maric
Minister of Finance and
Treasury of BiH Institutions
/s/
Dragan Vrankic
Minister of Finance
Federation of
Bosnia and Herzegovina
    /s/
Dragan Mikerevic
Prime Minister and
acting Minister of Finance
Republika Srpska




BOSNIA AND HERZEGOVINA

Supplementary Technical Memorandum of Understanding on Definitions and Reporting Under the 2002–2003 Economic Program

April 2003

This memorandum sets out the understanding between the Government of Bosnia and Herzegovina and the IMF mission regarding the definitions of quantitative and structural performance criteria and targets for the Stand-By Arrangement (Tables 1 and 2), as well as data reporting required for monitoring the implementation of the program.

I. Definitions

The following definitions are to be used in monitoring the program. In the following definitions, the end-quarter test dates apply to the last working day of each quarter for both banking and budgetary statistics.

A. Ceiling on the Stock of Gross Credit from the Banking System to the General Government

Definitions:

  • The general government is defined to include the State, Entity (Federation, and Republika Srpska), cantonal (Federation) and municipal budgets, Brcko budget, together with their respective extrabudgetary funds. The definition also includes the Goods Reserve Directorates of each entity. Extrabudgetary funds include, but are not limited to, the pension funds, health funds, unemployment funds, and children's fund in the two Entities and the State.

  • The banking system consists of the Central Bank of Bosnia and Herzegovina (CBBH) and the commercial banks in both Entities and the District of Brcko.

  • Gross credit is defined as all claims (e.g. loans, securities, bills, and other claims in both convertible marka and foreign currencies). For program purposes, those components of gross claims that are denominated in foreign currencies will be converted into convertible marka at the agreed accounting exchange rate prevailing on December 31, 2001.

Application of performance criteria:

  • The quantitative value of banking system claims on the general government will be monitored from the accounts of the banking system, as compiled by the CBBH, and supplemented by information provided by the Ministries of Finance of each Entity and the State.

  • The ceilings on the stock of gross credit from the banking system to the general government will be defined in terms of seven sub-ceilings that sum to the ceiling for the general government. These seven sub-ceilings will be on the stock of gross credit from the banking system to the State government, the Federation of Bosnia and Herzegovina government, the Republika Srpska government and municipalities, the Federation Cantons, the Federation municipalities and the extrabudgetary funds. For the purposes of program monitoring, compliance with the ceiling on banking system credit to general government will require that each of these seven sub-ceilings be observed independently.

  • The sums on-lent by commercial banks from long-term loans contracted by the government with international financial institutions and bilateral development institutions shall be excluded from the stock of gross credit of the banking system.

B. Operation of the Central Bank of Bosnia and Herzegovina

Under the Central Banking Law and the program, the CBBH is required to ensure that the value of its domestic liabilities does not exceed the convertible marka counter-value of its net foreign exchange reserves. Furthermore, the CBBH will not pay a dividend until its capital and reserves exceed 10 percent of its monetary liabilities.

Definitions:

  • Net foreign exchange reserves are defined as the value of foreign assets less the value of foreign liabilities, including assets and liabilities denominated in convertible currencies or convertible marka.

  • Foreign assets are defined as (a) monetary gold and (b) monetary authorities claims on nonresidents including currency bank deposits, government securities, other bonds and notes, financial derivatives, equity securities, and nonmarketable claims arising from arrangements between central banks or governments.

  • Foreign liabilities are defined to include: (i) foreign exchange and convertible marka balances on the books of the CBBH due to nonresidents, including foreign central banks (ii) credit balances due to foreign central banks, governments, and foreign financial institutions; (iii) forward and repurchase contracts of different types providing for future payments in foreign exchange by the CBBH to nonresidents; and (iv) any other liabilities due to nonresidents.

  • Monetary liabilities are defined as the sum of (a) currency in circulation, (b) credit balances of resident banks at the CBBH, and (c) credit balances of other residents at the CBBH.

  • Capital and Reserves are defined as (a) initial capital and reserves of the CBBH, (b) shares, and (c) accumulated profits of the CBBH since the beginning of its operation on August 11, 1997.

  • Free reserves of the CBBH are defined as foreign exchange reserves not utilized as backing for the currency. They therefore consist of the stock of CBBH net foreign exchange reserves less the stock of CBBH monetary liabilities.

Application of performance criteria:

  • Foreign currency holdings will be converted into convertible marka at the exchange rates of December 31, 2001, as published in the IMF International Financial Statistics. Valuation changes will therefore be monitored from the accounts of the CBBH, with information on net foreign assets provided monthly by the CBBH.

C. Ceiling on External Payments Arrears

Definitions:

  • External payment arrears are defined as overdue debt service arising in respect of debt obligations incurred directly or resulting from guarantees by the general government or the CBBH that have been called, except on debt subject to rescheduling or restructuring.

  • Debt obligations are defined as follows. 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 this program, 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. Under the definition of debt set out in point (a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

  • The general government is defined as above in section A.

Application of performance criteria:

  • The ceiling on external payments arrears applies to the stock of overdue payments on medium- and long-term debt contracted or guaranteed by the general government or the CBBH.

  • The ceiling on external payment arrears applies on a continuous basis.

  • The limit on the stock of external payments arrears also applies to the stock of overdue payments on short-term debt in convertible currencies with an original maturity of up to and including one year contracted or guaranteed by the general government. The limit excludes reductions in connection with rescheduling of official and commercial debt and debt buy-back.

D. Ceiling on Contracting or Guaranteeing of New Non-Concessional External Debt

Definitions:

  • Debt obligations are defined as above in section "C".

  • Concessional loans are defined as those with a grant element of at least 35 percent of the value of the loan, using currency-specific discount rates based on the commercial interest rates reported by the OECD (CIRRS). The average CIRRS over the last ten years—plus a margin reflecting the repayment period (1 percent for repayment period of 15-19 years; 1.15 percent for repayment period of 20-29 years; and 1.25 percent for repayment period of 30 years or more)—will be used as discount rates for assessing the concessionality of loans of a maturity of at least 15 years. For loans with shorter maturities, the average CIRRS of the proceeding six-month period (plus a margin of 0.75 percent) will be used.

  • Non-concessional external debt refers to all debt creating instruments with a grant element of less than 35 percent (as defined above).
  • New non-concessional external debt is defined as including all debt (as defined above) contracted or guaranteed during the program period. The ceiling will be on the increase in short-term, medium-term, and long-term new non-concessional external debt from August 2, 2002.

  • Short-term debt is defined as debt contracted or guaranteed with an original maturity of up to and including one year.

  • Medium-term debt is defined as debt contracted or guaranteed with an original maturity of greater than one year and up to and including five years.

  • Long-term debt is defined as debt contracted or guaranteed with an original maturity of greater than five years.

  • The general government is defined as above in section A.

Application of performance criteria:

  • The ceilings on the contracting or guaranteeing of new non-concessional external debt after August 2, 2002, will be defined for each test date. This excludes letters of credit at the State level for CIPS project financing up to 40 million KM.

  • The value of the stock of leases will be calculated as the present value, at the inception of the lease, of all lease payments expected to be made during the period of the leasing arrangement, excluding those payments that cover the operation, repair or maintenance of the property being leased.

  • Debt and leases will be valued in U.S. dollars at the exchange rates prevailing at the time the contract or guarantees become effective.

  • For program purposes, the following are not considered as non-concessional debt and thus are excluded from the calculation of non-concessional debt contracted or guaranteed: (i) borrowing from the IMF, the World Bank, EBRD, EIB, IFC, or bilateral cofinancing of lending by these institutions; and (ii) concessional loans.

  • The ceiling on contracting or guaranteeing of new non-concessional external debt excludes normal import-related financing.

E. Ceiling on Contracting or Guaranteeing of New Concessional Debt

Definitions:

  • Debt obligations are defined as above in section "C".

  • Concessional loans are defined as above in section "D".

  • The general government is defined as above in section "A".

  • The public sector is defined as general government and public enterprises

  • A public enterprise is defined as enterprises which are more than 50 percent directly or indirectly owned by the state.

Application of performance criteria:

  • Debt and leases will be valued in U.S. dollars at the exchange rates prevailing at the time the contract or guarantees become effective.

  • For program purposes, the following will be included in the calculation of the amount of external debt contracted or guaranteed: (i) borrowing from the IMF, the World Bank, EBRD, EIB, IFC, or bilateral co financing of lending by these institutions; and (ii) concessional loans.

    II. Data Reporting

    The Bosnia and Herzegovina authorities will report the following data to the Fund within the time limits listed below. The authorities will also provide, no later that the first week of each month, a summary of key macroeconomic policy decisions taken during the previous month. Any revisions to past data previously reported to the Fund will be reported to the Fund promptly, together with a detailed explanation. The Bosnia and Herzegovina authorities will make every effort to move speedily towards sending the required data by electronic mail.

    All magnitudes subject to performance criteria or indicative targets will be reported in millions of convertible marka where the corresponding target is in convertible marka, or in millions of U.S. dollars where the target is in U.S. dollars.

    The Bosnia and Herzegovina authorities will supply the Fund with any additional information that the Fund requests in connection with monitoring performance under the program on a timely basis.

    Monthly data reporting

    The Bosnia and Herzegovina authorities will send to the Fund the following data no later than 2 weeks after the end of each month:

    (i) Transfer payments by Entities to the State;

    The Bosnia and Herzegovina authorities will send to the Fund the following data no later than 3 weeks after the end of each month:

    (i) Debt service payments by the State to creditors;

    (ii) Pension funds payment data and cut-off dates for contributions collection;

    (iii) Stock of free reserves of the CBBH;

    (iv) The balance sheet of the CBBH;

    (v) The stock of reserves, including excess reserves at commercial banks.

    (vi) Balances held in escrow accounts;

    The Bosnia and Herzegovina authorities will send to the Fund the following data no later than 4 weeks after the end of each month:

    (i) Revenues, expenditures and financing data for all levels of government (including the State, Entities, and Cantonal (for FBiH));

    (ii) Revenues, expenditures, and financing data for the extrabudgetary funds (including health funds, unemployment funds, and (in the RS) the children's fund);

    (iii) Monthly Statistical Data on Economic and Other Trends review published by the Federation's Office of Statistics and Monthly Statistical Review published by the Republika Srpska Institute of Statistics;

    (iv) Data sheets issued by the Republika Srpska Institute of Statistics reporting on data that are not included in their Monthly Statistical Review.

    The Bosnia and Herzegovina authorities will send to the Fund the following data no later than 6 weeks after the end of each month:

    (i) Foreign exchange exposure indicators by bank in each entity, including indexed loans.

    (ii) Data on gross credit of the banking system to the consolidated general government broken down by bank as defined in I A. above.

    (iii) The commercial bank survey and monetary survey;

    (iv) Report on privatization revenues, including revenues received as prepared by the privatization agencies.

    (v) Interest rates data.

    Quarterly data reporting

    The Bosnia and Herzegovina authorities will send to the Fund the following quarterly data within one month of the end of each quarter.

    (i) Summary of government guarantees on quarterly basis;

    (ii) Summary of government loans and degree of concessionality (grant element);

    (iii) Summary of short-term loans by government on quarterly basis;

    The Bosnia and Herzegovina authorities will send to the Fund the following within 6 weeks of the end of each quarter.

    (i) Banking supervision indicators by bank in each Entity, including capital adequacy ratios, core and supplementary capital, selected liquidity indicators, non-performing loans and provisions for impaired loans and other assets.

    The Bosnia and Herzegovina authorities will send to the Fund the following quarterly data within two months of the end of each quarter.

    (i) Budget execution data by individual canton;

    (ii) Report on privatization revenues, including revenues received and use of funds;

    (iii) Execution of foreign-financed investment projects.


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