Republic of Montenegro and the IMF

Republic of Serbia and the IMF

Press Release: IMF Completes Second Review Under the Extended Arrangement, Approves Request for Waivers and Modification of Performance Criteria, and for Extension of Repurchases for Serbia and Montenegro
July 31, 2003

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Serbia and Montenegro—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding
July 11, 2003

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

Use the free Adobe Acrobat Reader to view Annexes A-C (81 kb PDF file).

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

Dear Mr. Köhler:

Firm implementation of our medium-term economic program supported by the Fund under the extended arrangement has ensured progress toward lowering inflation as well as setting the foundation for sustainable growth. To ensure continued progress, we have updated our economic and policy targets for 2003-05, as described in detail in the attached Memorandum on Economic and Financial Policies, to reflect the latest developments. On this basis, we request waivers for the non-observance of three end-June performance criteria, completion of the second review under the current extended arrangement and of the fourth and fifth financing assurances reviews, and a rephasing of the sixth purchase to July 28, 2003. Given our balance of payments need, we also request an extension of repurchase expectations arising in the period September-December 2003 to the obligations schedule.

We believe that the policies and measures described in the attached memorandum are sufficient to achieve our program objectives, but we stand ready to take timely additional measures and seek new understandings with the Fund, as 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 continue to be reviewed by the Fund on a semiannual basis, with the third review expected to be brought to the IMF Board in January 2004. The 2004 annual budget and financial program, the timetable for transferring central government deposits in commercial banks to the treasury single account in the NBS, exchange rate policy, and progress in bank and enterprise reform will be the main subjects of the third review. The fifth review will focus on the annual budget and financial program for 2005. Moreover, each purchase under the arrangement will continue to be subject to a review of the financing of the program.

Yours sincerely,


Branko Lukovac
Minister of Foreign Economic Relations
Serbia and Montenegro

Bozidar Djelic
Minister of Finance
Republic of Serbia
Mladjan Dinkic
National Bank of Serbia
Miroslav Ivanisevic
Minister of Finance
Republic of Montenegro
Ljubisa Krgovic
Central Bank of Montenegro



July 11, 2003

I. Introduction

1. This memorandum updates and supplements the Memorandum of Economic and Financial Policies (MEFP) attached to the Letter of Intent of April 1, 2003. It reports on recent developments under the program supported by the Extended Arrangement (EA) approved in May 2002 and updates the economic objectives and policy agenda for 2003. Annex A, attached to this memorandum, contains information on the quantitative performance criteria and indicative limits for 2003. Annexes B and C contain information on the structural performance criterion and benchmarks. Annex D (Technical Memorandum of Understanding (TMU)) defines the performance criteria and indicative targets and describes the reporting arrangements.

2. The new constitution—that replaced Yugoslavia by the state union of Serbia and Montenegro—has been in force since February 4, 2003. Both states are committed to the timely execution of expenditure commitments of the Union through transfers to the Union budget. A streamlining of responsibilities and institutional overlap will generate fiscal savings. Meanwhile, agreement has been reached on a plan to harmonize the two states' customs, trade and indirect tax regimes, as a step toward a Stability and Association Agreement with the EU.

3. Economic performance has been so far broadly in line with the 2003 targets but is subject to downside risks. Real GDP is projected to grow by 3½-4½ percent in 2003, driven primarily by increasing activity in services. However, mixed signals in recent data point to risks. Inflation declined further to 13½ percent by May 2003, consistent with the 9-11 percent target by end-2003. The external current account deficit (before grants) is projected to decline to around 11 percent of GDP in 2003 in line with the program target and recent trends. The overall balance, however, is expected to be weaker than programmed on account of lower FDI and "other capital inflows" in response to adverse changes in market sentiment. Accordingly, the external financing needs are estimated to be higher than earlier projected by about $120 million. This gap is expected to be filled by additional BOP/budgetary financial assistance from the EU and other donors. After declining in January-March 2003, the foreign exchange reserves of the National Bank of Serbia (NBS) have recovered and are projected to reach $2.9 billion (3.7 months of total imports) by end-2003.

Serbia and Montenegro: Key Macroeconomic Objectives and Policies, 2002-2005





Prel. Est.


Rev. Prog.



(Percentage change)

Real GDP Growth





Inflation (end period)






Of which: Montenegro





(In billions of US$)

Current account deficit (before grants)






In percent of GDP






Gross official reserves






In months of projected imports






(In percent of GDP)

Fiscal deficit






Of which: Serbia


(in percent of Montenegro's GDP)
















Fiscal deficit, excluding foreign-financed project spending






Government credit from the banking system






(In percent of end-year reserve money)

Reserve money growth






NDA contribution






NFA contribution






4. In Serbia, fiscal policy implementation remained on track in early 2003, while problems in government cash management complicated the conduct of monetary policy. The end-April performance criteria (PCs) were observed, with the exception of the NDA ceiling. The Serbian republican budget recorded a deficit of 0.6 percent of GDP in 2003 Q1, while the federal government deficit was about 0.3 percent of GDP. Revenue performance was weak in January—owing to the dismantlement of the payments agency (ZOP) and some glitches with the introduction of the single tax identification number—but has fully recovered since February. At the consolidated level, the deficit amounted to 0.6 percent of GDP reflecting surpluses of the local governments and indirect budget users. Meanwhile, the NDA of the NBS rose during January-April 2003 by the equivalent of 17 percent of end-2002 reserve money compared with a program ceiling of 13 percent. This resulted in part from difficulties in government revenue collection and cash management under the new payments system that led to a large accumulation of government deposits in commercial banks. However, NDA was brought under the end-April ceiling by end-May as fiscal-monetary coordination improved. Bank lending continued to grow in early 2003, albeit at a slower pace, and partially attributable to the financing of a repurchase from Italian Telecom of equity in Serbian Telecom. The indicative target for wage bill growth in large Serbian state enterprises was exceeded by about 2 percent at end-April, owing to faster-than-expected wage growth in EPS (electricity) and PTT (post and telecommunications, Annex A).

5. In Montenegro, budget implementation in early 2003 was constrained by a revenue shortfall. Revenue in the first quarter was about 11 percent lower than programmed, as the adoption of self-assessment of tax liabilities on January 1, together with preparations for VAT introduction on April 1, placed undue pressures on tax administration. This—together with limited financing—forced a containment of expenditures that kept the consolidated deficit at €11.9 million (0.9 percent of GDP) on the basis of below-the-line data, below the program target of 1.1 percent of GDP, while also giving rise to new arrears. Revenue returned to normal levels by May but, due to the earlier shortfall, is expected to be around €13 million (0.9 percent of GDP) lower than programmed in 2003 (or €20 million below the Budget).

6. Progress has continued on a broad array of reforms. Privatization has remained on track in Serbia with €125 million of sales in January to mid-May 2003, generating cash receipts of €85 million for the government. The four end-April structural benchmarks were not met—owing largely to disruptions in government activity in Serbia in the aftermath of the Premier Djindjic's assassination and the holding of Presidential elections in Montenegro—but progress has been made toward their implementation. Specifically, agreement on a timetable for harmonizing the trade, customs, and indirect tax regimes was reached in early July; the Serbian government approved restructuring plans for only 2 of the seven large state-owned enterprises by end-April, 2003, with the remaining ones expected to be approved by end-July; draft pension legislation in Montenegro has been approved by the cabinet and is expected to be approved by parliament by end-July; and the elimination of export quotas in Montenegro will be addressed in the context of the trade harmonization with Serbia by end-June 2003. Meanwhile, Serbia adopted a pension law in April, which based old-age benefits on the entire work history and tightened eligibility for disability benefits, in line with World Bank and Fund recommendations. Montenegro introduced a single-rate VAT on April 1, 2003.

7. In the aftermath of the Serbian Prime Minister's assassination, the government renewed its commitment to reform and cracked down on organized crime. Several thousand arrests were made during the state of emergency that followed, concomitant with a substantial reduction in criminal activity. While serious challenges remain, fight against organized crime has set the stage for a strengthening of the rule of law and an improvement in the business environment.

8. The debt restructuring process will continue with the implementation of Paris Club agreements, negotiations with the London Club, and regularization of other debt. Bilateral agreements have been concluded or initialed with 14 Paris Club creditors, with three remaining to be signed. Negotiations with other bilateral official creditors and the London Club are ongoing, with a view to achieving terms comparable to those agreed by the Paris Club. Following the reconciliation of London Club data in February, an Economic Paper will be submitted to the creditors in July as preparation for the resumption of negotiations. The 2004 budget will include an appropriation for debt service on London Club debt on Paris Club terms. Restructuring of the short-term debt owed to and by Russia on oil and gas imports is also under discussion.

II. Economic Policies for the Remainder of 2003

9. The current macroeconomic policy stance remains broadly appropriate. In line with the program, the fiscal deficit will be kept to 4.5 percent of GDP in 2003, unchanged from last year, to contain imports and the current account deficit to sustainable levels. The government will ensure that wage bills in state enterprises will be brought back within the program ceilings with a view to improving the financial position of these enterprises and signaling wage restraint to the rest of the economy. In light of a decline in the projected capital inflows owing to a deterioration in market sentiment and subdued inflation so far, a relaxation of the NFA and NDA targets for the remainder of the year will support the growth objectives without jeopardizing the inflation objective. Exchange rate policy will remain flexible and subject to review in light of trade, wage, and price developments.

A. Fiscal Policy


10. The deficit target of 4.1 percent of GDP in 2003 can be achieved with substantial efforts in revenue collection and containment of expenditure. The supplementary budget adopted in April was supported by two revenue measures implemented in May: an increase in the excise tax on gasoline and a seven-fold increase in administrative fees (yielding full-year revenue of SRD 3 billion and SRD 2 billion, respectively). In addition, the pension fund contribution rate was increased by 1 percentage point and the contribution base was widened (revenue of SRD 3 billion). As envisaged under the program, expenditure commitments will be maintained below the revised budget allocation by about 0.5 percent of GDP on a net basis. Savings relative to the budget will be effected in the wage bill (0.2 percent of GDP) through attrition (at least 700 employees) as well as a freeze on wages through the middle of the year. Other savings relate to transfers (0.2 percent of GDP), capital spending and net lending (0.2 percent), and nonpriority current spending (0.1 percent of GDP). At the same time, transfers to the Pension Fund will be increased by 0.2 percent of GDP to offset a revenue shortfall, and those to the Employment Fund by 0.1 percent of GDP for a one-off partial reduction of its outstanding arrears in unemployment benefits. Expenditure will be kept in check through the new treasury system which allows improved control over spending as well as the active use of advance monthly ceilings on commitments to avoid the accumulation of arrears. In any event, the government stands ready to take any additional measures needed should the deficit target be at risk.

11. Ambitious fiscal reforms will continue in 2003. In tax administration, following the relatively successful transfer of tax collection functions from ZOP to the Public Revenue Agency (PRA), efforts will focus on improved audits, the extension of the large taxpayers unit (LTU) to regional offices by end-September 2003 (SB-monitored), and preparations for the VAT introduction by January 2005 at the latest. The Treasury will continue to expand its role in managing budgetary expenditure and financing and increasingly use the Treasury Single Account (TSA) in the NBS. In this context, a decision to bring all line ministries and other direct budget users (except the Interior Ministry) under the TSA was adopted at end-June 2003 (SB-monitored) and is expected to be implemented in September; the Interior Ministry will be brought under the TSA by end-2003. In addition, a centralized payroll at the Treasury will be put in place by end-2003. To enhance treasury operations, coordination and information flow among the treasury, the PPA and the NBS will be ensured through (a) daily data-sharing and reconciliation and (b) regular meetings covering liquidity management and planning, including issuance of securities.


12. A projected revenue shortfall will be addressed by expenditure restraint. With a view to safeguarding the deficit target of 5.6 percent of Montenegro's GDP in 2003, the government adopted a revised fiscal plan that lowers expenditure commitments by €26 million from budgeted levels primarily in the areas of social transfers, investment, and goods and services, while also providing for the settlement of expenditure arrears accumulated earlier this year and the avoidance of new arrears. In addition, the government undertook to keep expenditures below the revised commitments by €7 million by cutting subsidies, as well as transfers to public organizations and the Pension Fund, unless revenues exceed their revised projected level. The wage bill will be contained through a rationalization of the civil service—that involves around 3,500 redundancies, primarily in the Ministry of Interior and the education sector, which account for the bulk of government employment—and foregoing further wage increases. In addition, to safeguard its debt position from unanticipated future liabilities, the government will assume no new guarantees.

13. Following the introduction of the VAT, fiscal reforms in Montenegro will focus on the pension system and expenditure and debt management. The introduction of VAT has been relatively smooth, with collection difficulties subsiding in May. Concerns over the adequacy of controls at the Serbia-Montenegro border and the capacity for processing revenues and refunds persist, however, and will continue to be addressed in the remainder of the year. A new Pension Law that lengthens the retirement age by 5 years in a phased manner and provides for the indexation of pensions according to the Swiss formula (equal weight to price and wage increases) will be adopted by end-July 2003 and come into effect no later than January 1, 2004 (SB). On the basis of a new law on Foreign Debt and Frozen Foreign Currency Deposits (FFCDs)-expected to be adopted during 2003-the government will assume, inter alia, obligations arising from old FFCDs in authorized banks (see below). In light of important fiscal implications, the Ministry of Finance intends to determine the timetable of FFCD repayments in consultation with the Fund staff. The implementation of a permanent treasury has set the basis for the improved monitoring of expenditure arrears, and further steps will be taken to establish the capacity for recording and auditing arrear stocks by end-October, 2003.

B. Wage and Pricing Policies in State Enterprises

14. Wage bills in state enterprises will be controlled to contain inflation pressures and encourage restructuring through labor shedding. Although the end-April ceiling was exceeded slightly—owing to one-off bonuses in EPS (electricity) and PTT (post and telecommunications)—the Finance Ministry will ensure that the targets for the remainder of the year are achieved by monitoring closely developments in wage bills as well as implementing retrenchment measures to improve the overall financial position of state enterprises. In the event of spin-offs as a result of restructuring, the wage-bill envelope monitored will include the wage-bills of the spun-off units.

15. The restructuring process of state enterprises is moving to the implementation phase. Despite delays in the government approval of restructuring strategies for 7 large state enterprises, the first phase of restructuring—involving redundancies and the spin-off of non-core activities—is underway in several large state enterprises and being prepared in others. The average electricity price was raised by 15 percent on July 1, 2003. In addition, EPS will streamline employment this year (through a 15 percent in core employment in Q3, and spinning-off and privatizing or closing non-core units); implement measures to raise the collection rate to 90 percent by end-2003, and 95 percent in 3 years; eliminate its arrears on accounts payable over the same time frame; and reorganize its core business in preparation for the privatization of selected spun-off components, as the necessary regulatory framework envisaged under the Energy Law is put into place.

C. Monetary and Exchange Rate Policies

16. Monetary policy will aim at further disinflation and strengthening the external position. The NBS has lowered somewhat the NFA accumulation target during 2003 owing to lower-than-originally-estimated FDI and other capital inflows, and larger BOP/budgetary financing needs that can be filled partly by additional foreign assistance. Consistent with a 11½ percent target for reserve money growth in 2003, the NBS has raised the NDA targets for the remainder of the year. The NBS will continue to follow credit developments closely and strengthen the implementation of prudential regulations to ensure that new lending decisions are sound. The NBS lowered the reserve requirement on deposits from 22 percent in April to 20 percent in May and 18 percent in July in conjunction with the ongoing shift of government deposits from commercial banks to the NBS.

17. A gradual, coordinated shift of government deposits to the NBS will improve the conduct of monetary and fiscal policies. To ensure unencumbered monetary policy implementation while maintaining stability in the banking system, the Serbian government will gradually shift its deposits in commercial banks to the Treasury Single Account in the NBS. Central government dinar sight and term deposits in commercial banks—which amounted to RD 15.2 billion at end-April and an estimated SRD 12.2 billion at end-June—will be further reduced to SRD 9.2 billion by end-September and SRD 6.2 billion by end-December 2003 (indicative target, Annex A). A timetable for the elimination of central government deposits in commercial banks will be a topic of the third review under the EA. If needed to offset the liquidity impact of this measure, and in line with the NDA targets, the NBS will provide liquidity support against collateral to the banking system through its standing credit facilities, which will be expanded to include repos and reverse repos during the second half of the year. The level of remuneration on the government's TSA funds will be set in line with international practice.

18. The NBS will expand its monetary policy instruments, while coordination between the NBS and the Ministry of Finance will be strengthened. The NBS introduced weekly auctions of two-week instruments to set the broad parameters of monetary policy in May 2003 and will put in place an emergency credit facility for solvent banks experiencing temporary liquidity problems by September 2003. In June 2003, the NBS and MOF established a policy committee to coordinate NBS' monetary operations and MOF's cash and treasury bill management (SB-monitored).

19. Exchange rate policy in Serbia will continue to strike a balance between safeguarding the external position and supporting disinflation. The NBS will maintain a flexible exchange rate policy taking into account conditions in the interbank foreign exchange market and developments in trade, prices, and domestic costs, with a view to supporting external competitiveness, while continuing to provide a nominal anchor for price expectations. To increase the role of market forces in the foreign exchange market, the NBS, by mid-2004, will phase out remaining restrictive regulations, while the Ministry of Finance will equalize the tax treatment of all cash financial transactions by end-2003. The requirement that NBS discount rate be used in calculating foreign exchange swap rates was eliminated on June 1, 2003.

D. Bank Restructuring and Financial Sector Supervision

20. Progress will continue in bank restructuring. The government has begun implementing a strategy aimed at resolving 12 banks in which it acquired significant stakes through debt-equity swaps in 2002. Based on diagnostic audit reports that are expected to be completed for 9 banks in the coming months, the government will reach agreement with the IMF staff, in consultation with the World Bank, on a plan for the largest bank by end-September 2003 (SB-monitored); resolution plans for the remaining 8 banks will be prepared by end-November 2003. Regarding the latter, tenders offering majority or controlling stakes for three banks will be launched by end-December 2003 (SB-monitored). Tenders for a strategic advisor to the government on bank privatization and for privatization advisers for the three banks have already been initiated. Meanwhile, the Bank Rehabilitation Agency (BRA) will strengthen control and governance in nationalized banks to preserve their value prior to resolution. Any envisaged use of budgetary resources will be incorporated in the 2004 budget. Finally, a privatization advisor will be appointed for Niska Banka by end-2003.

21. Financial sector supervision and regulation will be strengthened further in Serbia. Building on advances in developing the institutional framework for banking supervision—notably the adoption of a Supervisory Development Plan, and the establishment of a Supervisory Council—the NBS will place heightened emphasis on compiling timely analytical information on bank liquidity and solvency. In particular, monthly aggregate banking indicators will be developed with a view to establishing an early warning system by end-2003. To this end, banks will shift from quarterly to monthly reporting for off-site supervision by end-September; and on-site examinations will be intensified to ensure proper asset and risk classifications. In addition, the large loan registry will be enhanced to complement regular reporting; a regulation will be published requiring that banks' management boards issue an opinion on all large exposures; and consolidated supervision (that would include leasing subsidiaries) will be introduced in the new NBS law to be adopted by end-2003 (SB-monitored). The government will implement a framework for supervising non-bank financial institutions—involving comprehensive audits and setting minimum capital requirements for insurance companies—following the enactment of a new law on insurance expected by end-2003. On the regulatory side, the government will publish in the Official Gazette by end-September 2003 the newly adopted law on Accounting and Auditing prescribing the use of International Accounting Standards (IAS); and the NBS will issue the revised chart of accounts consistent with the new accounting law by end-September 2003.

22. In Montenegro, bank restructuring is supported by measures to strengthen supervision and the adoption of new laws. The forthcoming Law on Settlement of Obligations and Claims from Foreign Debt and Frozen Foreign Currency Savings (FFCD) will: (a) only allow transfer of liabilities from commercial banks to the budget at the time of privatization or liquidation, if they had been incurred under explicit government guarantee; (b) contain the budgetary impact of the transfer of liabilities to the Republic through phased repayment; (c) ensure that the CBM does not incur liabilities arising from the transfer to the budget of FFCD-related obligations with a view to protecting the financial soundness of the CBM; and (d) establish an effective mechanism to maximize collections against the bank assets underlying transferred liabilities. The institutional framework for banking supervision was modernized with the introduction of new regulations on licensing, minimum capital, asset classification and provisioning, connected lending and large exposures. Banks are required to prepare reports based on IAS. To eliminate the regulatory and supervisory loophole that exists for off-shore bank operations, the CBM has published the list of 432 offshore banks and instructed on-shore banks to cancel their accounts with these banks; to strengthen the CBM's legal power over offshore banks, the Ministry of Finance of Montenegro will provide individual decisions on revoking their licenses. The government will also adopt a new draft anti-money-laundering law, which is expected to be enacted by end-July, 2003.

E. Enterprise Restructuring and Privatization

23. Serbia is making progress in privatizing and restructuring socially owned enterprises. Fifty large socially owned enterprises will be offered through tenders in 2003, with the sale of the largest ones (Beopetrol and two tobacco companies) expected in the fourth quarter. About 1,000 small socially owned enterprises will be auctioned. In total, privatization is expected to generate cash receipts of about €400 million in 2003. Progress will also be made in restructuring 49 socially sensitive conglomerates—originally employing over 150,000 workers—prior to privatization to ensure orderly ownership transfer and employment reduction. About 50,000 workers have already been laid off with social support from the budget; a further 30,000 are expected to go through the same process this year at a cost to the budget of some €60 million. To continue ensuring transparency of the use of privatization receipts, all privatization proceeds will be channeled through the budget and spending will follow normal budgetary procedures. Excess privatization proceeds, after covering any shortfall in foreign budgetary financing, will be used to reduce net government indebtedness and—if consistent with achieving program objectives and in consultation with the Fund in the context of program reviews—to cover investment and restructuring costs.

24. Forthcoming legislative changes will reinforce the impact of rapid privatization in enhancing competition in the enterprise sector. Several new laws aimed at bolstering the business environment will be adopted by parliament in the second half of the year, including the laws on bankruptcy, on executive procedures and on business registration, as well as amendments to the laws on public procurement and on financial markets and securities.

25. Privatization in Montenegro is proceeding. In addition to privatization through tenders, auctions and sales of minority government share packets in the local stock exchanges, some companies' assets are privatized by applying the bankruptcy law adopted in 2002. The recent tender privatization of Montenegro Banka to a strategic investor will be followed by the initiation of the same process for Podgoricka Banka. In addition, the downstream component of the aluminum company (KAP) will be spun off and privatized this year. To ensure transparency, the Privatization Law will be amended by end-September 2003 to allow channeling all privatization proceeds to the budget without earmarking, with spending to follow normal budgetary procedures. Privatization sales are expected to yield €70 million in 2003; however, for caution, one-third of this amount has been budgeted.

F. Foreign Trade System

26. Agreement has been reached on an action plan to harmonize member states' trade regimes. Agreement on tariff rates has been reached on all goods, with most rates to be harmonized immediately and the remainder by 2006. Following the elimination of export quotas in Serbia early in the year, Montenegro plans to eliminate the small number of remaining quotas in the process of harmonization. All quantitative import restrictions in Serbia and Montenegro—other than those maintained for health, environment and security reasons—will be eliminated by end-2004. In addition, trade and custom laws in the two republics will be harmonized by end-2003, and free trade agreements with the neighboring countries will be signed and implemented.

III. Program Monitoring

27. Macroeconomic policy performance under the EA will continue to be monitored on the basis of quarterly quantitative performance criteria and indicative targets (Annex A). Progress in structural reform will be monitored through structural benchmarks on key policy measures (Annex C). To enhance program monitoring, both member states have appointed contact persons responsible for regular provision of standard data on fiscal and monetary developments as well as privatization, as described in the TMU.

28. Further improvements will be made in the provision of statistical data. Improving the timeliness of national accounts statistics is a top priority, with the 2001 GDP figures expected to be published by July 2003. Improvements will also be made in publishing data on wages and the external sector for both member states and SM. Montenegro will publish a consistent monetary survey starting from end-August 2003.

Union of Serbia and Montenegro: Technical Memorandum of Understanding

I. Introduction

1. This memorandum replaces the Technical Memorandum of Understanding attached to the Memorandum of Economic and Financial Policies of April 1, 2003. It sets out the understandings regarding the definitions of quantitative and structural performance criteria and benchmarks, as well as indicative targets, for the program supported by the Fund under an Extended Arrangement (EA), as well as the related reporting requirements. The key changes in this updated memorandum include definitional changes in the fiscal area stemming from the implementation of the new Constitutional Charter, an adjustor to the NFA floor, and data revisions owing to revised monetary data for end-2002.

2. To monitor developments under the program, the 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, 2002, except as noted below. Quantitative performance criteria and indicative targets for end-June, end-September and end-December 2003 are specified in Annex A of the Memorandum of Economic and Financial Policies (MEFP).

3. For program purposes, the public sector consists of the consolidated general government (comprising union operations, Serbian state and local governments, the Montenegrin state government, the Serbian and Montenegrin social security funds, and the Serbian special budgetary programs), the National Bank of Serbia (NBS), and the Central Bank of Montenegro (CBM). 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 2001 Manual on Government Financial Statistics, and will ensure that these will be incorporated within the definition of consolidated general government.

II. Quantitative Criteria: Definitions and Reporting Standards

A. Floor for Net Foreign Assets of the NBS and Program Exchange Rates

4. Definition. Net foreign assets (NFA) of the NBS consist 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 NBS holdings of foreign exchange in convertible currencies. Any such assets shall only be included as foreign reserve assets if they are under the effective control of, and readily available to, the NBS. In particular, excluded from foreign reserve assets are: frozen assets of the Union of Serbia and Montenegro (SM), undivided assets of the former Socialist Federal Republic of Yugoslavia (SFRY), long-term assets, NBS claims on resident banks and nonbanks, as well as subsidiaries or branches of SM commercial banks located abroad, any assets in nonconvertible currencies, encumbered reserve assets (e.g., pledged as collateral for foreign loans or through forward contracts), and precious metals other than gold. For program purposes, all euro and foreign currency-related assets will be evaluated at program exchange rates; for 2003, the program exchange rates are those that prevailed on December 31, 2002. In particular, US$1 = SRD 58.9848, €1 = SRD 61.5152, and SDR1 = US$1.3595. Monetary gold shall be valued at an accounting price of US$349.25 per ounce. On December 31, 2002 the NBS's foreign reserve assets as defined above amounted to US$2,280 million, including gold valued at US$114.2 million.

• For purposes of the program, foreign reserve liabilities shall be defined as any foreign currency-denominated short-term loan or deposit (with a maturity of up to and including one year), swaps (including any portion of the NBS gold that is collateralized), and forward liabilities of the NBS-to residents and nonresidents; IMF purchases; and loans contracted by the NBS from international capital markets, banks or other financial institutions located abroad, and foreign governments, irrespective of their maturity. Undivided foreign exchange liabilities of SFRY are excluded. On December 31, 2002, the NBS's foreign reserve liabilities, as defined above, to nonresidents were US$667 million and to residents were US$567 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, 2002. All changes in definition or in 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.

5. Reporting. Data on foreign reserve assets and foreign reserve liabilities of the NBS 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 NBS will provide the data at the indicated constant prices and exchange rates, as well as at current exchange rates. The NBS will report if any of the reported foreign reserve assets are illiquid or pledged, swapped, or encumbered.

6. Adjustors. For program purposes, net foreign assets will be adjusted upward pari passu to the extent that: (i) after December 31, 2002, the NBS 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 SM commercial banks abroad; and (ii) the restructuring of the banking sector by the Bank Restructuring Agency (BRA) involves a write-off of NBS foreign-exchange-denominated liabilities to resident banks. The net foreign assets floor will be adjusted downward by the shortfall relative to the programed level of net external budgetary financing cumulative from May 1, 2003 (US$109 million through end-June, US$258 million through end-September, and US$336 million through end-December) with a maximum adjustment of US$100 million. The net foreign assets floor will also be adjusted by the amount that revised estimates differ from the preliminary estimates of the end-2002 outcome.

B. Ceiling on Net Domestic Assets of the NBS

7. Definition. For purposes of the program, net domestic assets (NDA) of the NBS are 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 as specified above. The ceiling is established as the monthly average of each month with an end-month test date (i.e., the averages of April, June, September, and December, 2003, respectively). The monthly average of NDA for program purposes will be calculated as the difference of the monthly average of reserve money and monthly average of NFA. The monthly average of NFA will be adjusted so that the disbursements of World Bank program loans and EU macro-financial assistance are counted as if they occurred on the first day of the month in which they were effected. As of December 31, 2002, NDA of the NBS so defined were valued at SRD 1,951 million (Annex A).

8. Adjustors. The NBS's NDA ceiling is subject to the same adjustor for excess or shortfall in combined budgetary external financing and privatization proceeds for the consolidated Serbian government as defined in Section C, except that the limit for upward adjustment is SRD 2.5 billion. The adjustment for excesses/shortfalls in combined budgetary external financing and privatization proceeds is asymmetric: (a) it applies to the NDA ceiling but not to the NFA floor (except that shortfalls in budgetary external financing trigger an equal downward adjustment in NFA up to a limit of US$100 million); and (b) upward adjustments in NDA are capped at the equivalent of 0.2 percent of GDP, while no limits apply to downward adjustments. This treatment takes into account that: (a) privatization proceeds reflect partly sales to residents (i.e., not directly affecting NFA), so that a downward adjustment in NDA in response to higher than programmed privatization proceeds may not necessarily lead to a corresponding increase in NFA or may do so with a considerable lag (money demand is not stable in the short run); and (b) the need to safeguard foreign reserves.

9. Reporting. The ceilings will be monitored on the basis of daily data on NBS foreign reserve 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 NBS within four business days of the end of each business week. To facilitate program monitoring, the NBS will provide daily its foreign reserves liabilities, as well as the amounts and dates of World Bank and EU macro-financial assistance disbursements at the current and the agreed constant exchange rates.

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

10. Definition. The banking system comprises the NBS, commercial banks in Serbia, the CBM, and commercial banks in Montenegro. The consolidated general government was defined above.

• For program purposes, net credit of the banking system to the consolidated general government is defined as all claims other than frozen foreign currency deposit (FFCD) bonds (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 December 31, 2002 exchange rates. 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 2002, net credit of the banking system in Montenegro to the consolidated general government in Montenegro amounted to €-41.5 million (equivalent to SRD -2,551 million). At end-December 2002, net credit of the banking system to the consolidated general government so defined was SRD -15,121 million.

11. Reporting. The ceilings will be monitored using end-month data on the accounts of the banking system supplied to the European 1 Department of the Fund with a lag not to exceed three weeks.

12. Adjustors. For program purposes, the ceilings on net credit of the banking system to the consolidated general governments 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, 2003, and upward for any decrease. These performance criteria will be adjusted by the amount that revised estimates differ from the preliminary estimates of the end-2002 outcome. In addition, in the event of a shortfall in the sum of net foreign budgetary financing and privatization proceeds, the ceilings will be adjusted upward by 75 percent of the shortfall subject to the total adjustment limit of SRD 5 billion for Serbia's and €10 million for Montenegro's consolidated government. The ceilings will be adjusted downward for the excess of combined net external budgetary financing and privatization proceeds relative to budgeted levels that are not used (1) to reduce the government's external indebtedness by more than envisaged under the program, or (2) to cover investment and restructuring costs in consultation with the Fund in the context of reviews under the EA. Privatization receipts are defined to include all cash privatization receipts (defined as cash received by the government including the privatization agency), including those channeled to extrabudgetary funds. Net external budgetary financing is defined to include all budgetary (i.e., non-project) grants and loans, less amortization (on a cash basis). The estimation of the shortfalls (excesses) in the sum of net foreign budgetary financing and privatization receipts will be based on the following projections (cumulative from the beginning of 2003) with the actual inflows evaluated at the average exchange rates of the month when funds are received:

Serbia (In billions of dinars)


end-June EBS/03/41

end-June Revised



Foreign financing





Privatization proceeds






Montenegro (In € million)






Foreign financing





Privatization proceeds





D. Ceiling on Change in Domestic Arrears

13. For program purposes, indicative targets will be set on the change in domestic arrears. Separate indicative targets will be set for the consolidated general government of Serbia (including union-level spending), and the consolidated general government of Montenegro.

14. Definition

• For the purpose of establishing compliance with this indicative target, union-level expenditure is defined to comprise all budgetary activities specified in the Constitutional Charter, including the SM army and the SM pension fund for retired military personnel. The consolidated general government of Serbia is defined to comprise all budgetary institutions financed from the Serbian state 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, 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 of Montenegro is defined to comprise all budgetary institutions financed from the state 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; arrears related to the servicing of domestic debt [and nonpayment of budgeted transfers to finance union-level expenditures].

• 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.

• 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 2002, the stock of arrears at the union level was estimated at SRD 0 billion; and the stock of arrears of the consolidated general government in Serbia was estimated at SRD 44.3 billion.

• € denominated claims on government will be converted at the program exchange rate; claims denominated in currencies other than the € will first be converted at their respective program exchange rates against the € . 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 2002.

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

E. Definition of Reserve Money

16. Definition. Reserve money is defined as the sum of currency in circulation (NBY Bulletin, September 2000, Table 3A, column 8) and dinar reserves banks are required to hold at the NBS, plus excess reserves of the commercial banks. 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 NBS. Reserves that banks are required to hold were set at 20 percent effective on April 11, 2002 of the base as defined in NBS Decision of March 28, 2002. As of March 1, 2003 the required reserve ratio was raised to 23 percent but was reduced to 20 percent in two steps by May 11, 2003. Subsequent changes in the reserve requirement will be reflected in program definitions. 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 (SRD 174.1 million). Excess reserves include commercial banks' (1) balances in Giro accounts 620, 621, 623, and 625, (2) overnight deposit in account 205 at the NBS, (3) excess balances (with the shortfall in required reserves counted as negative excess) above required reserves on account 201 at the NBS, and (4) cash in vaults.

17. Data on reserve money will be monitored from the daily monetary indicators of the NBS, which shall be supplied to the European 1 Department of the Fund weekly by the NBS with a three-day lag. The end-month data is based on the NBS balance sheet, which is provided to the Fund with a lag of less than three weeks. On December 31, 2002, currency in circulation amounted to SRD 43,719 million, while required reserves amounted to SRD 15,843 million, and excess reserves to SRD 9,762 million. For program and projection purposes, monthly averages of reserve money and its components were used. On the assumption that the increase in required reserves would be met through a corresponding decline in excess reserves, the hypothetical December 2002 average required reserves associated with a 23 percent reserve requirement would have been SRD 18,043 million, while excess reserves would have been SRD 5,365 million. Data on effective reserve requirements and the deposit base used in reserve requirement calculations will be supplied to the European 1 Department on a ten-day basis with a lag of less than a week.

18. Adjustors. For program monitoring purposes, reserve money will be adjusted as follows. Should the standard reserve requirement increase (decrease) from the level prevailing on May 11, 2003, 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 deposit base used in the calculation of required reserves. Before making any changes to the reserve requirement, the NBS 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

19. 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.

20. 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 at the union level, by the Serbian and Montenegrin governments, and other public sector entities; arrears owed by Yugoslav Airlines; and arrears owed to Paris Club creditors, London Club creditors, and other creditors. Data on other arrears, which are reschedulable, will be provided separately.

G. Ceilings on External Debt

21. Definitions. The ceiling on contracting or guaranteeing of new nonconcessional external debt by the public sector with original maturity of more than one year 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 and EU, 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 normal short-term import credits.

22. 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, details on debt service obligations, 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

23. A macroeconomic monitoring committee, composed of senior officials from the Union Government, Serbian and Montenegrin Ministries of Finance, the NBS, 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

24. The authorities will notify the European 1 Department of the Fund of developments on structural benchmarks as soon as they occur. The authorities will provide the documentation, according to the dates in Annex C, 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

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

Public finance

26. Monthly data on public finance will require a consolidated budget report of the state governments (including union level operations), transmitted within four weeks of the end of each month comprising:

• The revenue data by each major item, including that collected by the state and local governments, as well as the social funds (also including "own revenue" of direct budget users);

• Details of the recurrent and capital expenditure of the union, state, and local governments, as well as the social funds (also including "own expenditure" of direct budget users); and

• Details of budget financing, both from domestic, and external sources, including total privatization receipts and Treasury bill issues and repayments (in the format described in paragraph 27).

In addition, Montenegro will augment the quarterly reporting of arrears data for the consolidated general government in Montenegro from November 2003 by separating out normal float; and providing end-quarter stocks of arrears and gross repayments of outstanding arrears during each quarter.

Monetary sector data

27. 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 reserves of the NBS at current and program exchange rates and gold prices, indicating amounts sold/bought at the auction, in foreign exchange offices and on the interbank market, inflows of foreign grants, inflows of foreign loans, and repayments of frozen foreign currency deposits.

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

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

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

• Outstanding stocks of Treasury bills, Treasury bill repayments made during the reporting period, and auction details (rates, amounts per maturity and number of banks participating in the auction per maturity).

• Interbank foreign exchange rates and volume of transactions, including rates and volume of trading outside the fixing session.

• Ten-day report on public sector borrowing and lending from commercial banks and the NBS.

• Ten-day report on required reserves and the reserve base.

28. The balance sheet of the NBS 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 NBS securities held by banks and by non-banks, as available to the NBS, 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. Credit to government by the banking system is provided with detailed breakdowns on the union, state, and local governments.

29. The following data will be transmitted on a monthly basis:

• NBS foreign exchange reserves held in accounts abroad, foreign banknotes, and foreign securities as well as interest income on foreign assets.

• Individuals' foreign exchange savings in top ten banks.

• Grants and loans disbursement as well as debt amortization and interest payments.

External data

30. 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 of exports and imports, separating out imported petroleum products.

In addition, Montenegro will provide quarterly updates of the Montenegro balance of payments, including projections for the current and subsequent year.

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.