Republic of Armenia and the IMF |
Press Release: IMF Completes Fifth Review Under PRGF for the Republic of Armenia, Approves Request for Extension of the Arrangement Through December 2004
May 3, 2004
Country's Policy Intentions Documents
Republic of Armenia—Letter
of Intent, Supplementary Memorandum of Economic and Financial Policies, and Technical Memorandum of
Ms. Anne Krueger
Acting Managing Director
International Monetary Fund
Washington, D.C. 20431
Dear Ms. Krueger:
The authorities of the Republic of Armenia held discussions with Fund staff during February 6-20, 2004, on the program supported by the Poverty Reduction and Growth Facility (PRGF). The purpose of this letter and the attached Memorandum of Economic and Financial Policies is to inform you of the progress in implementing the program, set out the policies for the period ahead, and request the sixth disbursement following the completion of the fifth review under the arrangement as well as the extension of the arrangement until December 2004.
The program is on track. Our economy has performed well and all quantitative and structural performance criteria for end-December 2003 were observed. Despite the progress achieved in recent years, we recognize that a number of significant challenges remain to sustain high economic growth and reduce poverty. To this end, our economic program for 2004 contains specific measures to address weaknesses in tax and customs administration, enhance fiscal transparency, reduce corruption, and press ahead with reforms in the energy and water sectors. The government intends to make these understandings public and authorizes the IMF to publish this letter, the attached memorandum, and the staff report.
The government believes that the policies and measures described in the memorandum are adequate to achieve the objectives of the program, but it stands ready to take any additional measures that may be required. The government will consult with the Fund in advance of the adoption of any such measures or on any revision of the agreed policies in accordance with the Fund's procedures for such consultations. It will also provide the Fund with the information required to assess progress in implementing the program.
1. This memorandum supplements the Memorandum of Economic and Financial Policies (MEFP) of October 30, 2003. It updates the government's policies for 2004 including specific measures for the remainder of the third annual program supported by the Poverty Reduction and Growth Facility.
A. Recent Developments
2. Economic performance remains strong in Armenia. Real GDP in 2003 surpassed earlier expectations, expanding by 13.9 percent. Grant-financed and private investments in construction as well as exports have been the main sources of the recent growth. At 8.6 percent, year-end inflation was above the central bank's target of 3 percent, owing mainly to higher prices of imported wheat flour and cereals. Broad money growth slowed down, toward the end of 2003, growing by 10.4 percent through December. The dram remained broadly stable in nominal and real effective terms, and gross international reserves ended the year covering 4.1 months of imports.
3. In 2003, the outturn of the fiscal deficit on a cash basis was better than expected at 1.5 percent of GDP (compared to 2.2 percent of GDP under the program) mainly because of lower-than-expected current expenditures. Current spending was lower because of delays in carrying out projects in the energy and transport sectors. The delays, in turn, are related to capacity constraints in project implementation units. Notwithstanding these constraints, we estimate that about 97 percent of the budgeted amount of social expenditures was executed in 2003. Although the nominal tax revenue target was met, the tax-to-GDP ratio fell because of stronger-than-expected growth in nontaxed activities and persistent weaknesses in tax and customs administration. Regarding the latter, we are taking concerted efforts to ensure that performance improves this year and in the medium-term (see below).
4. We met all of the program's quantitative and structural performance criteria at end-December 2003, as well as two of the five structural benchmarks scheduled for implementation up to March 2004. The benchmark on the simplified tax law was only partially met. As previously envisaged, the law was clarified to ensure that it applies to taxpayers and not economic activities. However, we decided not to proceed with the requirement of a three-year minimum for businesses to transfer from the profit tax category to the simplified tax category because we concluded that this measure would be easy to circumvent in Armenia by closing a company and re-opening it as a new one. The structural benchmark on the functioning of the post-clearance verification program at customs was not fully met. We completed two of the three steps required for this measure, namely the staffing of the unit and the preparation of an audit procedures manual. The remaining step to develop risk assessment selection profiles will require more work than previously anticipated and will be completed by June 2004. Lastly, the measure on registering traders at large retail markets was met, but the passage of the law on the use of cash registers is presently under Parliament review.1 This law is expected to be passed in May 2004.
5. We are making progress with the reform agenda. In the area of tax policy, and as a temporary measure to deal with the problem of low profit tax collections, we have introduced a minimum profit tax equivalent to 1 percent of companies' turnover. However, to avoid a higher effective tax rate on profits than the statutory rate of 20 percent, we have allowed for deductions in the energy, diamond, health, and education sectors. These sectors typically have profitability ratios below 5 percent of turnover. Despite our opposition to amendments that will weaken this measure, Parliament also introduced deductions for amortization of capital investments and indirect taxes. We will monitor the performance of this measure until mid-year and reconsider its usefulness at that time. More importantly, we have amended the enterprise profit tax law to limit deductions, tighten loss carryover provisions, and clarify depreciation rules. To improve the efficiency of the value-added tax (VAT) system, we have reduced further the number of import categories exempt from VAT at the point of entry. The reduction applies to about one-third of the value of remaining taxable imports (at 2002 values). We also raised presumptive taxes on certain activities such as cigarettes and diesel fuel, made the presumptive tax on natural gas used by vehicles a function of sales, increased the tax on gas pumps, and introduced a presumptive tax on petrol stations based on the number of gasoline pumps.
6. Regarding tax administration, legislation was passed to oblige employers to provide detailed information to the tax authorities about its employees. In addition, to strengthen the authority of the State Tax Service to collect tax arrears, we amended the legal framework to allow for the seizure of bank assets and debtors' receivables.
7. In the area of budget management and expenditure control, a legal framework was adopted setting up the basis for a reporting system for noncommercial organizations and a monitoring unit was designated within the Ministry of Finance and Economy. These entities are also being prevented from borrowing. An internal audit manual consistent with international standards was also adopted. This manual will govern internal audits in line ministries and their subordinate organizations.
8. In the banking sector, we are finally reaching an end to the resolution process for the two remaining intervened banks. The license of Credit Yerevan was revoked and a liquidator was appointed. A detailed action plan was adopted for the resolution of Armcommunications. We have also submitted for parliamentary approval amendments to the Law on Bankruptcy of Banks strengthening shareholder rights, and to the Law on the Central Bank of Armenia pertaining to the deposit insurance scheme.
9. Notwithstanding some delays, we are also making progress on the next set of reforms in the energy sector. In November 2003, the government approved the Financial Rehabilitation Plan (FRP) for the energy, water, and transport sectors and passed a resolution to enforce the implementation of institutional reforms and debt restructuring measures recommended in the plan. In the midstream sector, we established independent board of governors for the transmission, dispatch, and settlement companies.2 At the same time, we have established a single utility regulatory commission for the energy, telecommunication, and water sectors. Reflecting improved performance of the energy sector, total losses in distribution fell substantially in 2003 and collection rates have increased to almost 100 percent. The end-December 2003 indicative target on the primary balance of the energy sector was missed by a very small margin because of lower-than-projected revenues from thermal energy generation and exports. In the water sector, the government issued a tender to privatize the management of the Armenia Water and Waste Company. Lastly, the primary deficit of the water and irrigation sectors was 0.6 percent of GDP as programmed.
10. To achieve broader participation and to prioritize the policy objectives outlined in the Poverty Reduction and Strategy Plan (PRSP), we had two conferences with stakeholders and prepared an action plan with specific measures covering the period 2004-06. At the same time, a broad-based partnership agreement (which will become the participatory steering committee) and a working group were formed to implement PRSP-related policies. The 2004 budget allocations for the health, education, and other social sectors are broadly consistent with those outlined in the PRSP.
B. Economic Policies in the Period Ahead
11. During 2004, our macroeconomic policies will be focused on price stability, improving tax and customs administration, and enhancing fiscal transparency. Together with other structural policies, this will help us to maintain a high rate of economic growth while continuing our efforts to reduce poverty and corruption. Some of these policies were listed in the October 2003 memorandum of economic and financial policies but will be supplemented by additional policies as noted below. Tables 1 and 2 present the quantitative targets and key structural measures for the period ahead.
Monetary policy and the financial sector
12. The recent increase in wheat and cereal prices that led to higher consumer prices is an unfavorable development that punishes the most vulnerable in society. At the macroeconomic level, monetary policy is being tightened to prevent a spillover effect into other prices and to bring the 12-month rate of inflation to less than 3 percent by end-year. We are also taking a closer look at developments in the wheat market in the region and the commercialization structure in Armenia to ascertain the presence of monopolistic behavior and remove any market distortions that may exist.
13. The more conservative stance of monetary policy for 2004 is reflected in the revised financial framework for our program (Table 1). Base and broad money are projected to expand by about 4 and 10 percent, respectively. The Central Bank of Armenia (CBA) will widen its range of tools to support its monetary policy, including through a gradual buildup of the stock of government securities. To support the tighter monetary policy stance, we anticipate a slight decline in net international reserves in 2004. Aside from temporary (intra-week) smoothing of fluctuations in the value of the dram, the central bank will ensure exchange rate flexibility.
14. The central bank will strive to improve banking supervision to keep pace with the evolving banking system. During the next year, we will develop, in consultation with Fund staff, a program to establish an independent unified financial sector supervisory authority. We recognize, however, the importance of ensuring a successful transformation of the banking system before setting up a unified supervisory agency. We would also like to promote the development of mortgage lending with a view to facilitating broad-based access. As a first step, we will focus on the enhancement of the market infrastructure in the primary market by further enhancing the legal framework, ensuring adequate competition in mortgage lending, and establishing a sound framework for assessing, documenting, and publishing developments in the real estate market. Lastly, in line with the agreement recently signed with a foreign investor, we will ensure that Armcommunications bank is either recapitalized or liquidated by end-June 2004.
15. The program for 2004 is in line with the budget and broadly consistent with the PRSP. It targets an overall deficit of about 1.9 percent of GDP. Revenues and expenditures as a share of GDP will be lower in 2004 compared with 2003, owing to a sharp decline of grants from the Lincy foundation and the correspondingly lower capital expenditures that these grants finance. The tax revenue target for 2004 (AMD 260 billion) is based on the projection of nominal GDP growth of 10 percent. The targets for the second half of the year may be adjusted if GDP developments during the first half of the year lead to a change in the annual projection. The increase in current expenditure envisaged in 2004 is mainly due to higher social expenditures (0.6 percent of GDP) and an increase in the wage bill (0.1 percent of GDP). We will include in the budget any further external grants or concessional borrowing for infrastructure development and other capital expenditures that may be secured later this year.
16. We are confident that the tax measures recently approved by Parliament in the context of the 2004 budget are sufficient to achieve our tax revenue objectives. We envisage other policies to improve the efficiency of the tax system, such as expanding the regime of temporary importation for processing, developing a deferral payment system for VAT on large imported capital goods not currently taxed at the border, and introducing a control system to enforce the collection of the excise tax on beer.3 Furthermore, and in light of recent problems with the enforcement of tax collection and the system for VAT refunds, we will:
17. To improve the functioning of customs administration, we intend to focus on four areas where progress is most needed and achieve the following results by mid-2004. First, we are working to ensure that declared transaction prices are used to the greatest extent possible for assessing customs duties. To this end, we will increase the share of the value of commercial imports for which the approved customs value is determined on the basis of the declared transaction price from 30 percent in the last quarter of 2003 to at least 50 percent in the second quarter of 2004. Second, we will develop risk assessment selection profiles for the operations of the recently established post-clearance verification unit and will begin conducting audits and preparing audit reports to be shared with Fund and World Bank staff. Third, we will implement a direct trader input system at customs points whereby commercial importers and brokers will be allowed to input directly their customs declarations into the Customs computer system. Lastly, we will prepare a disciplinary code of conduct for customs officials and require them to sign a commitment of compliance.
18. Notwithstanding the beneficial effects of the near-term tax and customs administration measures mentioned above, there are still remaining challenges that need to be addressed in the medium-term to enhance efficiency and compliance and ensure fiscal sustainability. At present, a complex and fragmented set of laws and regulations creates incentives for evasion and side payments to tax and customs inspectors and taxpayers alike. In this regard, we have begun preparatory work to build a unified tax code containing an internally consistent set of tax laws and regulations and a better balance between direct and indirect taxation (less reliance on taxes on goods and services compared to income and profit taxes). This work will necessitate a broader agenda for the key remaining reforms in the areas of tax and customs administration. Such an agenda will be embedded in a two-year action plan to be prepared in consultation with Fund staff by the third quarter of 2004. The action plan will contain immediate steps to revamp the management structure of the STS and customs service. We will also consider integrating these units into a single structure with direct reporting lines to the Ministry of Finance and Economy. Compliance will be enhanced through further measures to improve transparency and the identification and registration of taxpayers, developing a tax culture, and preventing the accumulation of tax arrears. A strengthened legal and judicial framework designed to address fraud and corruption (see below) will support these reforms. The plan will also contemplate legislation aimed at eliminating remaining VAT exemptions on imports, rationalizing simplified and presumptive taxes (the above tend to transform the VAT into a single-stage tax, thus nullifying its advantage), eliminating unjustified deductions and exemptions, and broadening the tax base. Lastly, the plan will also need to tackle remaining problems at customs administration and fully implement the system for customs valuation and control and ensure full transparency of customs operations.
19. Despite some delays, we intend to make progress on budget monitoring and control. In order to reduce the fiscal risk stemming from a lack of disclosure and control of noncommercial organizations (NCOs) budget allocations, the process of hiring and training for staff in the NCO monitoring unit will be completed by May 2004, line ministries and regional centers will receive full information and begin reporting by July 2004, and the consolidated accounts will be prepared by the Ministry of Finance and Economy by September 2004. In addition, all NCOs will be required to disclose their bank statements to line ministries. Lastly, as defined in the GFS Manual, we have determined that all NCOs as well as joint stock companies that provide nonmarket goods and services belong to the general government.
20. We are in the process of improving the coverage of government statistics and we will begin in May of this year to publish consolidated monthly central government data including the SFSI with a one-month lag. The next major step will be the compilation of quarterly consolidated general government data covering the consolidated central government5 and the local governments with a 2-month lag beginning in July 2004.
21. On the implementation of PRSP-related work, we are preparing a comprehensive set of monitoring indicators that will be used to assess progress in implementing the poverty reduction strategy. During the next 6 months, we will also prepare the medium-term expenditure framework for 2005-07 in consultation with Fund and World Bank staff. We are also improving infrastructure in the education and health sectors and will ensure a sizable increase in family allowances and pensions that are targeted to those most in need in the 2005 budget.
Other structural policies
22. Over the next six months, we intend to continue implementing the Financial Rehabilitation Plan for the energy and water sectors. The energy sector is moving away from a single-buyer approach towards direct contracting between the distribution company, power generators, and other service providers. To this end, the utility regulatory commission will create by end-June 2004 an appropriate regulatory framework to ensure the proper functioning and transparency in these sectors. At the same time, regulations will be issued and implemented to include electricity market structure and market rules, rules of electric service, connection policy, and financial and operational audit procedures. The commission will also implement the license monitoring system, which includes closely monitoring the safety and reliability criteria for the operation of the system. By mid-year, the Ministry of Energy will be transformed into a policymaking body, all business management functions will be vacated, and the management of midstream operations will be subject to performance-based management contracts. Lastly, by July 2004, Armenergo will be extricated from all cash and non-cash transactions, and will be prevented from making any new contracts in the energy sector. Moreover, all of Armenergo's outstanding liabilities to the government will be written off, its remaining debt restructured, and the company's removal from the enterprise registry will be initiated through the court system by October 2004.
23. Water tariffs will gradually rise over the next few years to reach operations and maintenance cost recovery levels by 2007. In the irrigation sector, we are developing the capacity of the user associations to enable their efficient management of the infrastructure. Over the next three years, tariffs for bulk and end-users are also expected to increase gradually, approaching operations and maintenance cost recovery levels by 2007. The government will actively monitor the impact of these increases on the poor, and will increase family support benefits and social security outlays beyond those envisaged in the PRSP.
24. Despite some delays, we recently completed and made public an anti-corruption strategy that contains an action plan to deal with corruption in areas such as tax and customs services, the legal system, the judiciary, and law enforcement. The strategy focuses on five key elements: (i) legislative reform aimed at removing discrepancies in different pieces of legislation that create ambiguities conducive to corruption, including amendments to the procedures of the criminal code in order to clarify and specify criminal sanctions for corruption and protect witnesses; (ii) harmonizing legislation with international standards and ensure freedom of information on activities of the government and public agencies; (iii) strengthening the monitoring of fraudulent activity in the banking sector, including money laundering; (iv) reforms in tax and customs administration; and (v) public sector reform including developing public financial audit standards and strengthening the role of parliament in the audit process. During the next few weeks, we will conduct a series of consultations to seek feedback from parliament, civil society, and donors and discuss technical assistance and implementation details. We will also form a monitoring group that will coordinate and oversee the implementation of the strategy and adapt it over time. The group will comprise a wide range of representatives from civil society, members of Parliament (including opposition parties), and the government.
C. Program Monitoring
25. Program monitoring will be based on semi-annual quantitative performance criteria and quarterly indicative targets as well as structural performance criteria and benchmarks (Tables 1 and 2). There will be a semi-annual review based on end-June 2004 data and measures covering up to July 2004. The quantitative performance criteria include ceilings on the net domestic assets of the CBA, net domestic banking system credit to the central government, domestic expenditure arrears of the central government and the State Fund for Social Insurance, net disbursements of short-term external debt, contracting or guaranteeing of new non-concessional medium- and long-term external debt, and external arrears. They also include floors on net official international reserves of the central bank, tax revenues of the central government, and the overall cash balance of the central government. Regarding the tax revenue target, the definition of tax revenues has been clarified to exclude VAT refund claims in arrears or any non-programmed operation with state-owned companies used to settle tax arrears. There is an indicative band on reserve money and an indicative floor on the primary balance of the energy sector. Details on the definitions, monitoring, and adjustors of quantitative performance criteria are contained in the attached Technical Memorandum of Understanding (TMU). A request for the seventh disbursement under the PRGF arrangement is contingent upon the observance of the measures envisaged, the performance criteria set out in Tables 1-2, and the completion of the sixth review under the program expected on October 15, 2004. To insure the effective monitoring of the program, the relevant ministries, the CBA, the State Tax Service, the Customs Committee, and the National Statistics Service will compile and share with Fund staff all core economic data on a timely basis as specified in the TMU.
GOVERNMENT OF ARMENIA
This memorandum defines the benchmarks, performance criteria, adjustors, and reporting modalities referred to in the Supplementary Memorandum of Economic and Financial Policies.
I. Quantitative Targets
1. The program targets a minimum level of net official international reserves (NIR) of the Central Bank of Armenia (CBA). The stock of such reserves will be calculated as the difference between total official gross international reserves and official reserve liabilities. Total gross official international reserves are defined as the CBA's holdings of monetary gold (excluding amounts pledged as collateral or in swaps), holdings of Special Drawing Rights (SDRs), any reserve position in the IMF, and holdings of convertible currencies in cash or in nonresident financial institutions (deposits, securities, or other financial instruments). Gross reserves held in the form of securities are marked to market. Gross reserves are reported separate from the balance on the government's Special Privatization Account (SPA) and excluding capital subscriptions in foreign financial institutions and illiquid foreign assets. Official reserve liabilities shall be defined as outstanding liabilities to the IMF and convertible currency liabilities of the CBA to nonresidents with an original maturity of up to and including one year. NIR is monitored in U.S. dollars, and, for program monitoring purposes, assets and liabilities in currencies other than the U.S. dollar shall be converted into dollar-equivalent values using the exchange rates as of December 31, 2003 (Attachment III, Table 1).
2. The program targets a maximum level of net domestic assets (NDA) of the CBA. For program purposes, NDA is defined as reserve money minus Net International Reserves (NIR) plus medium- and long-term liabilities of the CBA. To evaluate program targets, the dram-equivalent values of NIR and medium- and long-term liabilities are calculated at the end-2003 official exchange rate of dram 566.0 per U.S. dollar. NDA is composed of net credit to the general government; outstanding credit to domestic banks by the CBA (including overdrafts) minus liabilities not included in reserve money (exclusive of accrued interest), and other items net.
3. Reserve money targets are indicative and include a floor and a ceiling. They are subject to a daily bound of plus or minus 2 percent computed from the quarterly average standard deviation of excess reserves held by banks in percent of quarterly reserve money during the previous four years. Reserve money is defined as the sum of currency issue, required and excess reserves, and current and time deposit accounts of certain resident agents.6
4. The stock of net credit from the CBA to the government includes the CBA's holdings of treasury bills and treasury bonds less all types of government deposits (including deposits of donor-financed project implementation units, the Lincy foundation, and balances of proceeds from the sale of humanitarian assistance). Treasury bonds are valued at the purchase price and treasury bills are valued at the purchase price plus the implicit accrued interest.
5. Net credit from commercial banks to the government includes: (1) gross credit to the government less government deposits (including the counterpart funds of certain government onlending to the economy financed by the Lincy Foundation and the World Bank); and (2) banks' holdings of treasury bonds (valued at the purchase price and excluding accrued interest) and treasury bills (valued at the purchase price plus the implicit accrued interest). Net credit of the banking system to the government is the sum of net credit from the CBA and net credit from commercial banks.
6. External debt limits apply to all forms of new nonconcessional medium- and long-term external debt7 with original maturities of more than one year, which are contracted or guaranteed by the government or the CBA. Excluded from the limits are changes in indebtedness resulting from refinancing credits or rescheduling operations, sales of treasury bills or treasury bonds to nonresidents (provided the sales go through the regular auction mechanism and involve no exchange rate guarantees), concessional loans, and credits extended by the IMF.8 Except for normal import-related credits, there is a zero limit on short-term external debt (obligations with original maturities of up to one year) contracted or guaranteed by the government or the CBA. Transactions subject to debt ceilings shall be valued in the contracted currencies and converted into U.S. dollars at the average monthly market exchange rate in the month when the commitment was contracted.
7. External arrears will consist of all overdue debt-service obligations (i.e., payments of principal and interest) arising in respect of public sector loans contracted or guaranteed including unpaid penalties or interest charges associated with these arrears.
8. The balance of the central government on a cash basis is defined as the sum of domestic banking system net financing, domestic nonbank net financing, and external net financing to the government. Net banking system credit to the government equals the change during the period of net credit to the government. Nonbank net financing equals the sum of: (1) the change during the period of outstanding treasury bills and bonds to nonbanks (including accrued interest for treasury bills and excluding accrued interest for treasury bonds);9 and (2) any other disbursement or transaction that increases nonbanks' claims on the central government plus withdrawals from the special privatization account or the treasury subaccount containing privatization proceeds in dram, less amortizations made by the central government to private resident nonbank agents. External net financing equals total debt-increasing disbursements from non-residents to the central government less total amortizations from the central government to non-residents. All foreign-currency denominated transactions are recorded in drams using the prevailing exchange rate at the time of the transaction.
9. The U.S.-based Lincy Foundation extends grants to finance various investment projects. The project implementation units, which carry out Lincy-financed projects, maintain accounts at the CBA. These grants are recorded in the fiscal accounts as external grants on the revenue side and as foreign-financed capital expenditure on the expenditure side. In addition, any loans extended by the U.S.-based Lincy foundation to finance investments and that are intermediated through the banking system are recorded in the financial accounts as a financing item below the line and are thus excluded from net lending.
10. Foreign currency proceeds from selling enterprises are deposited into the special privatization account. The account is held at the CBA and the proceeds are invested abroad together with the CBA's international reserves. These proceeds are included in the definition of the monetary accounts of the CBA as part of net foreign assets with a counter entry in other items net. Any budgeted withdrawal from the SPA will be accounted for as privatization proceeds used to finance the budget and will be recorded below the line. Any unanticipated withdrawal from the SPA will be recorded below the line as privatization receipts; these withdrawals, however, will be replenished during the same fiscal year. Domestic currency proceeds from selling enterprises to residents are deposited in a subaccount of the treasury single account.
11. Tax revenues are defined in accordance with Government Financial Statistics (GFS), 1986, section IV.A.1. Total revenues collected by the State Tax Service (STS) and the Customs Committee (CC) are classified as follows: VAT (of which: presumptive tax on cigarettes, petroleum, and diesel), excises (of which: presumptive tax on cigarettes, petroleum, and diesel), enterprise profit tax, personal income tax, land tax, customs duties (of which: presumptive tax on cigarettes), other presumptive taxes, simplified tax, property tax, and other taxes (of which stamp duties and environmental taxes). For evaluating the performance criterion on tax collection, recorded tax revenues will exclude any tax payment related to non-programmed transfer, loan, or recapitalization operation carried out with state-owned companies or any VAT refunds in arrears.
12. The program targets maximum levels for the stock of domestic arrears of the central government and the State Fund for Social Insurance (SFSI). Domestic arrears are defined as follows. With respect to wages, contributions to the pension fund, family allowances, and amortization and domestic interest payments, the stock of arrears is defined as all unpaid claims outstanding at the end of the month. This excludes technical arrears of up to AMD 0.5 billion that could arise because of minor delays in the execution of these expenditures. For all other expenditure categories, arrears are defined as the stock of unpaid claims, as verified by the recipient of the goods and services, which has been outstanding for more than 30 days as of the end of the month. However, at year-end all outstanding claims must be settled as required in the budget law.
13. The program targets the primary balance of the energy sector, which is defined as current total revenues less total expenditures excluding interest payments and foreign-financed capital expenditures. The government will provide a detailed quarterly cash flow for the energy sector. The energy sector is defined by the following state-owned companies: (1) Yerevan thermal power plant; (2) Metsamor nuclear power plant; (3) Vorotan hydro-power plants system; (4) High Voltage Electricity Network; (5) Armenergo; (6) the Settlement Center; (7) the Dispatch Company; and (8) Armgasard.
14. The quantitative performance criteria and benchmarks under the program are subject to the following adjusters:
• Foreign-financed project disbursements: the target on the cash balance of the central government will be adjusted downward (upward) by the full amount of cumulative higher (lower) than programmed foreign-financed project disbursements. The programmed amounts are shown in Table 2 below.
• World Bank budget support: the following targets will be adjusted by the full amount of higher than programmed World Bank direct budget support: NIR (upward), NDA of the CBA (downward), and net credit to the government (downward). The programmed amount is shown in Table 3 below.
• KfW loans: the target on the stock of net domestic assets of the CBA will be adjusted upward (downward) by the amount of any non-programmed disbursement (repayment) from (to) KfW. The adjustment will be made at program exchange rates.
III. Prior Actions, Structural Performance Criteria and Benchmarks
15. VAT refunds in arrears. VAT refunds in arrears are defined as all outstanding VAT refund claims during each month that have not been accepted (and refunded), offset, or rejected after the 90 day processing period.
16. Customs operations. The customs committee will develop risk-based assessment selection profiles based on recommendations provided by the January 2004 technical assistance report from the Fiscal Affairs Department "Key Areas for Further Tax and Customs Reforms"; issue rules for conducting external audits on import declarations based on the risk assessment selection profiles, and prepare a report for the Chairman of the Customs Committee on the operations of the post-clearance verification unit. The latter will contain information on the number of audits and infractions, the amounts involved, and remedial measures imposed as well as information on whether those measures have been successfully implemented.
17. Direct contracting in the energy sector and initiation of liquidation of Armenergo. (i) The Public Utilities Regulatory Commission will adopt regulations establishing market rules in the energy sector in Armenia. These regulations will specify a risk-sharing mechanism that assigns financial responsibility in the case of unexpected changes to the cost structure (including arising from changes in the mix of generation) if those changes affect the basis upon which the pre-determined electricity tariffs for end-users were determined.10 (ii) The government will adopt and publish a government decision prohibiting Armenergo from signing any new contracts and mediating any cash or non-cash transactions in the energy sector.
18. VAT deferral system. The development of the deferral payment system for VAT for large imported capital goods (valued more than US$ 100,000) not currently taxed at the border will comprise: (i) setting up a multi-agency commission (Ministry of Finance and Economy, State Tax Service, Customs Committee, Ministry of Trade) that will establish the technical criteria for granting deferrals; and (ii) the signing of a memorandum of understanding between the Customs Committee and the State Tax Service on exchange of information and the initiation of the deferral system on a pilot basis. The criteria for determining the items that will be covered under the pilot project will be developed in consultation with Fund staff. The information and technical criteria for granting deferrals will be determined by the new commission. Among other things, this commission will determine the goods or activities that would be covered by the deferral system; whether all or specific enterprises are to be eligible; documentation requirements; the length of deferral (no more than 12 months); and the scope of the pilot project (selected activities or selected taxpayers). In addition, the exchange of information, specified in the memorandum of understanding between the Customs Committee and the State Tax Service, would include identification of taxpayer, content of information, format of data, form of transmittal, and frequency. Under the deferral system, Customs would allow imports without payment of VAT based on established criteria and provide documentation to the State Tax Service. The Tax Service would develop procedures to establish a liability record, revise tax forms to account for deferred VAT, and monitor compliance of taxpayers.
19. Collection of tax arrears. The report will identify different types of arrears such as for: (i) very large cases; (ii) difficult cases; and (iii) normal cases that are potentially recoverable. It will also evaluate the potential for recovery and appropriate actions to that end. The government will also draft legislation to determine the measures needed for collecting old debts, seeking bankruptcy proceedings or direct seizures and write-off uncollectible debts from the STS accounts along with appropriate safeguards and independent review.
20. System of tax audits. The following actions will be carried out (i) establish a system of risk assessment profiling of taxpayers with a view to moving toward risk-based audit selection; (ii) put in place procedures to specify tax auditors' access to bank information within the overall tax audit framework and use these as a base to draft legislation that will progressively liberalize bank secrecy laws and allow tax administration easier access to such information; (iii) establish a national audit plan with headquarters setting numerical targets for regional offices in terms of the economic sectors and types of taxpayers that are to be audited, as well as for the types of audits (partial audits, advisory visits, and VAT refunds examinations). The plan will be prepared on an annual basis with quarterly reporting and midterm reviews and with emphasis on partial audits. Comprehensive audits should be used only for high-risk taxpayers or when partial audits reveal serious underpayment of tax liabilities; (iv) develop a detailed audit manual covering all aspects of the audit function beginning with indirect audit methods.
21. Budget reporting of noncommercial organizations. All NCOs will report to their authorizing bodies: (i) information on their 2004 budgets by July 2004; and (ii) quarterly data on their cash flow operations, as well as balance sheet information, by July 2004, covering the first two quarters of 2004. Authorizing bodies will begin reporting the consolidated NCO data to the MFE by August 2004.
IV. Data Reporting
22. The government will provide the IMF the information specified in the following table.
1 The law designates the sectors where the cash registers should be used and establishes deadlines for their installation.