Republic of Montenegro and the IMF
Republic of Serbia and the IMF
Press Release: IMF Executive Board Completes Fourth Program Review and Eighth Financing Assurances Review Under an Extended Arrangement with Serbia and Montenegro, and Approves US$95.6 Million Disbursement
December 15, 2004
Country's Policy Intentions Documents
Free Email Notification
Serbia and MontenegroLetter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding
Mr. Rodrigo de Rato
Dear Mr. de Rato:
Firm implementation of our medium-term economic program supported by the Fund under the Extended Arrangement (EA) has permitted good progress in stabilization and reform. To ensure continued progress and address new challenges, we have updated our economic and policy targets for 2004-05, as described in detail in the attached Memorandum on Economic and Financial Policies. On this basis, we request: (a) completion of the fourth semi-annual review (including the eighth financing assurances review) under the EA; (b) waivers for the non-observance of an end-June, 2004 performance criterion (the passage of the Serbian bankruptcy law) and two end-September, 2004 performance criteria (contracting or guaranteeing new nonconcessional external debt from multilateral creditors by the public sector in Montenegro; and non-assumption by the public sector of enterprise debt to banks in Montenegro); (c) the purchase of SDR 62.5 million following the completion of the fourth review; and (d) a rephasing of purchases for the remainder of the program by combining the tenth and eleventh purchase, to become available upon completion of the fifth review which would be postponed to cover the end-December 2004 test date. The non-observed quantitative performance criteria for which waivers are requested were missed by small margins and the Serbian bankruptcy law was adopted with a short delay. We are taking measures to improve policy implementation in these areas.
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 Fund staff, as necessary, to keep the program on track. We will remain in close consultation with the Fund staff on the adoption of these measures, and in advance of any revisions to the policies contained in the attached MEFP in accordance with the Fund's policies on such consultations. We will provide all information to the Fund that it requests to assess the implementation of the program. The program will continue to be reviewed by the Fund, with the discussions for the next review, together with the Article IV consultation, expected in January 2005. The next review will focus on progress in structural reforms (including budgetary employment reduction, enterprise restructuring and privatization, bank reform), and on the implementation of fiscal, monetary, incomes and exchange rate policies. Moreover, each purchase under the arrangement will continue to be subject to a review of the financing of the program.
1. This memorandum updates and supplements the Memorandum of Economic and Financial Policies (MEFP) attached to the Letter of Intent of May 21, 2004. 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 the remainder of 2004 and for 2005.1
2. The performance under the program supported by the Extended Arrangement with the Fund is broadly on track. While four end-June performance criteria (PCs) were not met, all but two end-September PCs were observed. The end-June ceilings for the NDA of the central bank and bank credit to government in Serbia were missed, but observed at end-September. In addition, the end-June PC on contracting or guaranteeing new nonconcessional external debt from multilateral creditors was breached by Montenegro; this PC, and that on debt guarantees was also breached at end-September. The Montenegrin government is committed to avoiding similar breaches in the future. The end-June structural PC for Serbia on electricity tariffs was met on time, while that on the bankruptcy law was met with a slight delay owing to scheduling difficulties in Parliament. The end-June and end-September indicative targets on the wage bill of state enterprises were exceeded. A number of additional indicative targetson net credit to government, arrears, banking system NDA, and central government dinar depositswere not met at end-June, with the latter two missed also at end-September, calling for improved policy implementation. End-June structural benchmarks on the VAT law and bank privatization, and recovery of banks assets were met (the latter with some delay). The end-September structural benchmarks in Serbia and Montenegro on asset recovery have not been met. Both governments are seeking to address these delays.
3. Strong growth in 2004 has been overshadowed by accelerating inflation and an increasing external imbalance.
4. Fiscal policy in Serbia was tightened after June to safeguard annual inflation and external balance targets, while tax reform advanced. Total revenue was broadly in line with the program at end-September, and expenditure has been under tight control since July, which corrected for higher than expected spending in the first six months. The shift towards indirect taxes advanced with the elimination of the wage bill tax (July 2004), rationalization of the social contribution rates and bases (July and September 2004), increases in excises on gasoline, diesel, and cigarettes (July 2004), a new lottery tax (July 2004), reduced corporate income tax to 10 percent (September 2004), and cancellation of the financial transaction tax (effective January 2005). The January 1, 2005 introduction of the VAT will further advance this shift. In Montenegro, total revenue fell below programmed levels despite strong VAT revenue performance, but prudent budget execution has kept the deficit in line with the program.
5. Monetary policy was also tightened at mid-year to rein in inflation and the widening external deficit. The NBS raised the interest rate on its bills during June-July, and increased the required reserve ratio by 3 percentage points from August. These measures tightened liquidity by about 0.6 percent of GDP.
6. The implementation of structural reforms has resumed since July. Serbian Parliament approved a package of 17 economic reform laws in mid-July. Privatization has recommenced with the issuance of tenders for 8 socially-owned enterprises. Financial sector reform is continuingJubanka has been offered in a public tender as programmed and its sale to a strategic investor is expected to be completed around the end of the year. Tenders for sale of Continental Banka and Novosadska Banka were published in late September. The conversion of all Paris and London Club as well as FFCD-related liabilities into state-owned equity in banks to be privatized is also essentially complete.
II. Economic Objectives and Policies
7. The economic objectives for 2004-05 and beyond reflect robust growth in incomes while addressing higher inflation and safeguarding a sustainable external position (Table):
8. Economic policies will be geared to support sustainable growth while narrowing the external current account deficit. Fiscal policy and monetary policy will support current account adjustment while the health of the financial sector will be improved and structural reforms accelerated to increase export potential with the support of appropriate safety-nets.
9. The PRSP process will continue to guide the development agenda and social policies. The PRSPs adopted by the Serbian and by the Montenegrin governments in late 2003 outline the key reforms. Social spending will be protected to provide a safety net for those affected adversely by reforms, while its efficiency will be enhanced through the improved targeting of benefits.
A. Fiscal Policy
10. Fiscal policy in 2004 and 2005 will continue to anchor the stabilization effort and improve medium-term sustainability. Fiscal policy will be tightened by 1.4 percent of GDP in 2004 and 1.2 percent (1.7 percent excluding redundancy payments) in 2005, largely through cuts in expenditures. Reflecting the tightened fiscal stance, prudently assumed privatization proceeds (1.6 percent of GDP), and foreign disbursements (1.1 percent of GDP), the fiscal program for 2005 envisages a build-up of government deposits equivalent to 0.6 percent of GDP. As in previous years, privatization proceeds beyond program targets will be used to reduce net government indebtednessand if consistent with achieving program objectives and in consultation with the Fund in the context of program reviewsto cover investment and restructuring costs.
11. Fiscal policy for the remainder of 2004 will be tighter than programmed to reduce external vulnerabilities. To scale back government spending as agreed in the third review, the Parliament passed a budget amendment bill in October (prior action for the Fourth Review). The supplementary budget includes an additional cut of 0.2 percent of SM GDP in view of heightened pressure on the current account deficit in addition to budgetary reallocations in line with the understandings under the Third Review (MEFP paragraph 16). The supplementary budget (i) substantially increases allocations for the social funds to ensure timely payment of entitlements; (ii) allocates resources for payment to London Club creditors (2.5 billion dinars); and (iii) cuts spending relative to the appropriations in the 2004 Budget Law, notably subsidies to agriculture and transportation, net lending, bank restructuring, and goods and services. With these measures, the consolidated fiscal deficit of the Serbian general government is projected to decline from 3.0 percent of GDP in 2003 to 1.7 percent of GDP in 2004 (from 2.5 percent to 1.2 percent excluding FLFPs).2
12. Fiscal policy in 2005 will be further strengthened to support the stabilization effort. The overall deficit of the Serbian general government in the 2005 budget (whose submission to Parliament is a prior action for the Fourth Review) will be cut by 1.1 percentage points to 0.6 percent of GDP (a surplus of 0.1 percent excluding FLFPs).3 Since total revenue as a percentage of GDP is expected to fall in 2005 with the legislated reduction of the tax burden, expenditure cuts will bear the brunt of the adjustment while laying a foundation for further fiscal consolidation in the medium term. With a tighter deficit and projected privatization proceeds of 1.6 percent of GDP and net external disbursement of 0.9 percent of GDP, the budget sector is expected to reduce it demands on net domestic financing by 2.0 percent of GDP in 2005.
13. The tax burden will continue to shift from labor to consumption to increase savings, growth and job creation. A broadly revenue neutral two-rate VAT (standard rate 18 percent, reduced rate 8 percent) will replace the retail sales tax in January 2005. Fees and taxes on securities transactions will be eliminated by January 1, 2005. The various changes in taxes are projected to lower tax revenue to 35.9 percent of GDP in 2005, partially compensated by strengthened collection of nontax revenue boosted by higher dividends from state-owned enterprises. Total revenue would decline by 0.8 percentage points to about 39.5 percent of GDP.
14. Expenditures will be reduced and rationalized. Virtually all non-interest current expenditure items will need to be rolled back as a share of GDP. At the same time, the budget will need to make room for larger interest obligations, and higher severance payments to support structural reform. Expenditure as a share of GDP is projected to decline to 40 percent.
15. The policies will be supported by reforms in tax administration. To ensure a smooth introduction of the VAT in January 2005, remaining outstanding enabling decrees for the VAT implementation were issued in October 2004. In addition, the government will request a follow-up VAT technical assistance mission to visit Belgrade in March 2005 to assess the initial VAT implementation and recommend early corrective measures, if needed. In line with international best practice, the selection criterion for large taxpayers will be changed to turnover by end-2004, rather than the current practice based on total revenues collected from 3 tax sources. Taxpayer services will be strengthened. By end-March-2005, taxpayer services for (a) tax law interpretation, (b) filling tax returns, and (c) tax liability information will be extended to all major tax offices country-wide in Belgrade, Novi Sad, Ni, and Kragujevac. Finally, to further enhance restructuring and improve financial discipline, the government will develop a plan to reduce enterprise arrears to the budget and social funds by end-November (structural benchmark).
16. Public expenditure management will benefit from Treasury reorganization and increase control over indirect budget users. As part of its reorganization, the Treasury will issue an action plan by March 2005 that will fully integrate the Public Payment Agency into the Treasury. With the Road Directorate brought into Treasury Single Account in August, all direct budget users are now fully covered by the TSA. Over the medium term, all accounts of indirect budget users will also be brought into the TSA. As a first step, the Treasury will draw up by June 2005 a full inventory of all indirect budget accounts denominated in dinars and foreign currency. To further strengthen public expenditure management, the government will by end-June 2005 submit a law requiring local governments to publish audited budget accounts.
17. Reform of the payroll system is a high priority. The MOF will implement a work program to pull together the present disaggregated payroll data bases and to move to a more centralized payroll processing that will allow fuller control over wage expenditures. To achieve these objectives, the MOF will undertake by end-March an audit of basic personnel records in budget institutions. In addition, it will review the Systematization Act for any vacant position that is not filled for more than a year and recommend their elimination. The MOF will strengthen its payroll division to allow it to initially construct and maintain a simple but reliable centralized database for all direct budget users. During 2005 this division will develop a program, jointly with the Budget Inspection Service, to carry out routine payroll management checks against the data base of key indirect budget users. By January 2006, the division will develop and introduce a standardized software package and complementary information system.
18. Fiscal adjustment continues in Montenegro. The 2004 general government deficit (before grants and foreign loan-financed projects, FLFPs) is targeted at €36.1 million, or 2.4 percent of Montenegrin GDP. In 2005, the fiscal deficit (before grants and FLFPs) will fall to €25.8 million, or 1.6 percent of Montenegrin GDP. Government approval and public announcement of the additional 2004 cuts and submission to the Parliament of the draft budget for 2005 in line with this MEFP will be prior actions for Board consideration of the fourth review. Over the medium term, the government is committed to continue lowering the deficit to ensure fiscal and external sustainability.
19. The government will maintain a predictable tax environment and protect the revenue base. Tax reforms will be implemented only in the context of annual budget laws or amended budgets, making revenue-reducing tax policy changes conditional on the availability of adequate revenues or offsetting measures to safeguard the deficit target. Such tax policy changes will not be considered if (i) actual recurrent budget revenues are below the budgeted levels, and/or (ii) the budget has accumulated new expenditure arrears during the year. The government will not extend the VAT rebate program based on retail receipts beyond November 2004. The second step of lowering PIT and social contribution rates that was originally envisaged on December 1, 2004 will only be followed by further reductions in PIT rates during 2005 and beyond if actual revenue performance exceeds projected levels by a sufficient margin to allow such cuts. The decision on further PIT rate reductions will be taken in close consultation with IMF and World Bank staff. There will not be further reductions in social contribution rates during 2005. The planned reduction in the Corporate Income Tax rate from 20 to 9 percent will only be effective from 2006. Finally, the government will refrain from extending new exemptions or differential VAT rates to any sector, and avoid restructuring tax debt in a manner that would undermine its tax collection over the medium term.
20. Fiscal adjustment will also be supported by prudent expenditure policies. To reduce the high share of non-discretionary expenditures, the government will cut budget-financed employment from its end-2003 level of 26,000 by 1,000 by end-2004, and by a further 800 in each quarter of 2005. Discretionary spending will be further reduced in 2005, with the amount of net lending and subsidies falling to 0.9 percent of Montenegrin GDP. The government will also avoid new privatization-related spending obligations (i.e., no subsidies or price guarantees will be provided to privatized companies, and no debt to third parties assumed unless already guaranteed by the government). The government will refrain from spending in the first half of 2005 the €7 million reserve it has set aside in the 2005 budget for the contingency that the December 2004 reductions in social contribution rates result in additional needs for transfers to the Pension and Health Funds. Finally, the government will cap the total amount of subsidy paid to Nikic Steelworks under its privatization contract at €0.8 million in the draft 2005 budget and phase this subsidy out completely by end-2008.
21. The government will continue implementing a cautious strategy of domestic borrowing. Government net domestic financing (excluding FFCD repayment) will not exceed €12 million in 2004, and €10½ million in 2005. The government will continue developing the treasury bill market extending the maturity profile of its debt. The government will also continue increasing the share of treasury bills in total domestic financing, and will eliminate reliance on non-transparent loan agreements with individual banks and companies by end-2005.
D. Monetary and Exchange Rate Policies
22. The monetary program for the remainder of 2004 will continue tight credit policy to help contain domestic demand and inflationary pressures. For the year, end-period NFA are programmed to be broadly unchanged, while monthly average NDA will decline slightly from August, implying a 3.5 percent growth in reserve money during the last quarter. Dinar broad money and credit to the economy are projected to rise by 13.8 and 38½ percent during 2004, respectively. The NBS will stand ready to sterilize foreign exchange inflows to contain credit expansion.
23. The efficiency of money market operations will be strengthened. To increase its capacity to manage market liquidity, the NBS will expedite the implementation of repo operations. The government will submit to Parliament a draft law on the settlement of government liabilities to the NBS by end-November 2004, with a view to facilitating by end-2004 the restructuring of government debt held by the NBS into marketable bonds eligible for repo operations. In addition, to enhance public liquidity management and avoid implicit subsidies to banks, the remaining republican government and NBS deposits will be withdrawn from commercial banks by end-2004, except from one bank undergoing privatization. Meanwhile, by end-October 2004, the Ministry of Finance and the NBS will establish joint procedures for strengthening the coordination of fiscal and monetary policies, forecasting market liquidity and demand for T-bills and NBS-bills, determining the schedule for issuing these bills, and projecting government deposit flows.
24. Macroeconomic risks related to rapid credit expansion will be assessed. The NBS will prepare by end-March 2005 a detailed loan survey and a regular reporting standard, providing data on loans-and leasing contracts extended by Serbian bank-owned leasing companies-by industry, currency denomination, term-structure, and type of borrowers (including a breakdown of loans to households into consumer and mortgage lending), to monitor these risks. To increase transparency in the banking sector, the NBS will publish quarterly reports on banking industry trends starting with the report for end-2004.
25. The NBS will implement prudential measures to contain macroeconomic risks resulting from rapid credit growth. The rapid credit expansion, particularly the strong increase in credit to households, has contributed to an unsustainable rise in the current account deficit. Against this background, the following measures will be implemented:
26. Exchange rate policy will continue to balance the objectives of reducing inflation and the external imbalance. Against the background of a large and growing current account deficit, exchange rate policy will be flexible and contribute to improving competitiveness, while at the same time strengthening confidence in the dinar. Exchange rate policy will be assessed frequently in light of current account, wage, and inflation developments.
E. Bank Reform and Financial Supervision
27. The NBS will substantially strengthen financial sector supervision. To this end, it will group all banks and insurance companies according to their respective risk assessment, with their supervisory plans clearly laid out by end November 2004, and cross-check banks' submitted reports against external audit reports by end-2004. An on-site assessment of the bank posing the largest potential systemic risk will be launched by end-2004, and the bank will adopt a time-bound plan by end-2004 to strengthen internal controls and governance. To send a clear signal that regulatory forbearance is ceasing, the NBS will further strengthen on-site and off-site supervision, and strictly enforce existing regulations. In particular, the NBS will withdraw the license of banks that do not meet the €10 million minimum capital requirement by end-2004, unless they are recapitalized by reputable investors with banking experience or meet the requirement through a merger (structural benchmark). The license of further banksif anyfailing to meet the minimum capital requirement will be withdrawn by end-March 2005. To improve financial sector transparency and market discipline, all banks, insurance and leasing companies will publish IAS compliant end-2004 financial results by end-June 2005. The NBS will also strictly enforce prudential requirements for insurance companies and require comprehensive year-end audits, with management letters provided to the NBS.
28. In Serbia, progress in bank privatization and resolution will continue and governance in BRA-controlled banks will be strengthened. Building on progress in privatizing Jubanka, the BRA will launch the privatization tender for Nika Banka by end-2004 (structural benchmark). Meanwhile, management in the two largest banks with state-majority holdings has been improved. For Vojvodanska Banka, the tender for a privatization advisor was issued on October 7, 2004 with a view to appointing the advisor by end-February 2005, and launching the tender for its privatization in the third quarter of 2005. Concurrently, with bilateral assistance, the BRA will further strengthen its reporting requirements, control mechanisms, and governance in other nationalized banks to preserve their value prior to resolution. After some delays due to legal procedure, the BRA will launch the sale of its residential mortgage loan book by end-2004 and initiate the sale the 25 largest corporate and commercial unimpaired (non-public, not on privatization list, not bankrupt) loans by end-March 2005. Meanwhile, Parliament will adopt new laws on Deposit Insurance, Bank Liquidation, and Bank Rehabilitation Agency by end-March 2005, after consultation with World Bank and IMF staff.
29. In Montenegro, banking supervision will remain vigilant and bank privatization and asset resolution will continue. The CBM has further strengthened banking supervision, in particular by further improving compliance with Basel core principles and strengthening the focus on risk management. Moreover, it has remained vigilant in light of rapid credit expansion, inter alia by ensuring that a moderate deterioration in the quality of banks' loan portfolio was appropriately accompanied by an increase in loan-loss provisioning. To further reduce state influence in the banking sector, the government will launch a tender for a privatization advisor for the largest state-owned bank by end-November and sign the contract with the advisor by end-2004. The privatization tender will be launched by end-April, 2005. The government and the CBM will also prepare a strategy by end-2004 to divest all state minority holdings from the banking system, and refrain from increasing this stake in the banking system in the meantime. The government will begin by end-2004 the sale of non-financial assets carved out from the banking sector, initiating by end-March 2005 the sale of at least 50 percent of the unimpaired assets, and by end-June 2005 all remaining unimpaired assets. To level the playing field for banks and improve Treasury cash management, all republican government deposits with commercial banks will be transferred to the single treasury account in the CBM by end-2004 (structural benchmark), with the exception that republican government deposits at Podgoricka Banka will decline by €2 million from their end-August level, and fall to zero by end-June 2005. Finally, enhanced balance sheets for the central bank and for deposit money banks will be available by end-2004 to improve the monitoring of banking and fiscal developments.
F. Enterprise Sector
30. Wage bills in state enterprises will continue to be controlled to contain inflation pressures and encourage restructuring. To help ensure that the state enterprise wage bill remains under control, the government will pass by end-November a decree requiring ex ante approval by the Ministries of Labor and Finance for wage increases in 8 public utilities. On this basis, the government agrees to treat the wage bill ceiling on the 7 monitored public utilities as a performance criterion from end-December 2004.4 The wage bill in the monitored state enterprises in 2005 will be allowed to grow by 7 percent on an average basis. To facilitate the necessary cost rationalization, detailed business plans, including new organization charts (sistematizacija) will be prepared by end-2004 for most monitored public utilitiesincluding for NIS, EPS, and ZTPclearly showing redundant workers. Redundancy payments for the laid-off workers will be covered from the non-wage budgets of the enterprises and from the Transition Fund in the budget (0.1 percent of GDP). In the event of spin-offs as a result of future restructuring, the monitored wage-bill envelope will be adjusted downward for the wage-bills of the spun-off units.
31. Accelerating the privatization and restructuring of socially-owned enterprises is critical for improving export performance and for rapid sustained growth. To this end, we will ensure that:
32. To accelerate privatization, we envisage debt workouts for large socially-owned enterprises coordinated by a unit under the Deputy Prime Minister's supervision. The framework for such agreements will be strengthened through amendments to the Privatization Law by [end-2004], which will enshrine the principle of write off of enterprise debts to state creditors and public utilities, conditional upon privatization. To enable the privatization of highly indebted enterprises by reducing their debt without creating moral hazard, write-offs of tax and social contribution arrears, and of obligations to public utilities or state-owned banks will be conditional on actual sale or final bankruptcy, and most often involve a haircut for remaining creditors imposed by an inter-ministerial negotiating group. Private creditors may accept haircuts in return for prompt payment, or may be forced to do so by public sector creditors wheneveras is most often the casepublic sector creditors account for the majority of claims.
33. An effective bankruptcy process provides a critical building block of the government's strategy for strengthening enterprises' financial discipline. The bankruptcy process will become fully operational by end-February 2005, following the adoption of bylaws to the Bankruptcy Law and the establishment of: (a) a Supervisory Body to license, supervise, and regulate bankruptcy trustees; (b) a specialized unit within the Privatization Agency to act as bankruptcy trustee for state- and socially-owned enterprises. As part of this process, an amendment to the Law on the Privatization Agency enabling the PA to act as the bankruptcy trustee agency for state- and socially-owned enterprises will be enacted by end-2004 (structural performance criterion). The government will complement rapid progress toward a functioning bankruptcy process by initiating bankruptcy procedures under the new regulations against three large, heavily indebted, and loss-making socially-owned conglomerates under restructuring programs by end-March 2005.
34. The Serbian government is firmly committed to improving the financial performance of the railway company (ZTP) by accelerating restructuring and downsizing employment. Delays in restructuring and excessive employment have created large losses and imposed a substantial budgetary burden through annual subsidies of ¾ percent of GDP. Against this background, the Ministry of Capital Investment will prepare by end-February 2005, in consultation with the Ministry of Finance and World Bank and Fund staff, a restructuring plan drawing on the Business Plan for 2004-2008 elaborated by the consulting company Booz-Allen-Hamilton. This restructuring plan will provide detailed timetables covering 2005 for (a) reducing labor redundancies; (b) spinning off all non-core activities of ZTP with a view to privatizing them; (c) potentially closing loss-making secondary railway lines, if the respective segments are not taken over by investors in the form of subconcession contracts; and (d) raising the price of passengers' tickets and freight tariffs early in the year. Moreover, the government will submit to parliament by end-March 2005 a transportation law agreed with the World Bank that provides for the unbundling of ZTP into separate transportation and infrastructure companies.
35. The Serbian government will continue restructuring public utilities based on strategic plans.
36. Privatization in Montenegro is proceeding. The Nikic steel company has been privatized, hotels are being sold at a brisk pace, and the large aluminum company (KAP) is at an advanced stage in its privatization process. In addition, Montenegro Telecom is expected to be offered for sale in the first half of 2005. The republican budget's privatization proceeds have been conservatively budgeted at €6 million in both 2004 and 2005, but can be higher without affecting deficit targets (i.e., additional privatization receipts will be offset with equal reduction of net domestic financing). The government will refrain from granting electricity subsidies to privatized companies or extending any government guarantees.
G. Foreign Trade System
37. The foreign trade system is being harmonized internally and liberalized through regional agreements. Following an agreement on a timetable to harmonize the trade, customs, and indirect tax regimes of the two republics adopted in August 2003, tariff rates have been harmonized with the exception of tariff lines for 56 agriculture products and of special import levies and seasonal tariffs for a range of additional products. All export and import quotas have been eliminated. A Joint Customs office with competence on trade with EU countries has been set up. Even though the harmonization processas requested by the EUis not yet complete, the EU has signaled that it could adopt a more flexible approach towards the preparation of a feasibility study for the Stabilization and Association Agreement. Significant progress in the resolution of the outstanding issues with the European Commission relating to sugar trade has allowed the resumption of sugar exports to the EU. A trade agreement to liberalize trade in textiles with the EU is expected to be finalized by the end of the year. Discussions on bilateral Free Trade Agreements with neighboring countries within the initiative of Stability Pact-aimed at facilitating trade through harmonized rules and standards, and simplified customs procedureshave progressed well. Free Trade agreements with Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Moldova, and Romania have been ratified and implemented, while work is underway to review the trade agreement with Macedonia. Preparations for the WTO accession process are continuing, with the first meeting of the Serbia and Montenegro Task Force for WTO accession envisaged in 2005. Customs operations are expected to be further strengthened, including at the Union level. To avoid backtracking on reforms and maintain a competitive market environment, both member states will refrain from introducing or intensifying import restrictions. Serbia and Montenegro agree to improve the comparability of respective external sector data, and provide foreign debt data on a periodic basis.
III. Program Monitoring
38. Macroeconomic policy performance under the EA will continue to be monitored through quarterly quantitative performance criteria and indicative targets (Annex B). Progress in structural reform will be monitored through structural performance criteria and benchmarks on key policy measures (Annex D). Quarterly targets for 2004 remain as set in the Third Review documents except for a revision in the end-December ceiling on Montenegro's nonconcessional multilateral borrowing and an end-December performance criterion added for the wage bill of monitored state-owned enterprises in Serbia. Quarterly performance criteria are also proposed for end-March, 2005. Parliamentary approval of a revised 2004 budget for 2004 in Serbia and parliamentary submission of annual 2005 budgets for Serbia and for Montenegro in line with policies described in this memorandum, as well as issuing tenders for 3 socially-owned enterprises in Serbia, government approval and public announcement of the additional 2004 budget cuts in Montenegro, and submission to federal parliament of amendments to two laws governing union-level employment will constitute prior actions for Board consideration of the fourth review under the Extended Arrangement (Annex D).
1. This memorandum replaces the Technical Memorandum of Understanding attached to the Memorandum of Economic and Financial Policies of May 21, 2004. It sets out the understandings regarding the definitions of quantitative and structural performance criteria, benchmarks, and 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 external debt ceilings and data revisions.
2. To monitor developments under the program, the authorities will provide the data listed in each section below to the European 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-December 2004, end-March, end-June, end-September and end-December 2005 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 and Montenegrin 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.
5. Reporting. Data on foreign reserve assets and foreign reserve liabilities of the NBS shall be transmitted to the European 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, pledged, swapped, or encumbered.
6. Adjustors. For program purposes, net foreign assets will be adjusted upward pari passu to the extent that: (i) after September 30, 2004, 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 Agency for Deposit Insurance, Rehabilitation, Bankruptcy, and Liquidation of Banks (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 programmed level of net external budgetary financing cumulative from December 31, 2003 (US$217.4 million through end-December 2004), and cumulative from December 31, 2004 (US$40 million through end-March 2005, US$40 million through end-June 2005, US$95 million through end-September 2005, and US$95 million through end-December 2005) with a maximum adjustment of US$100 million. The net foreign assets floor will also be adjusted by the amount that the end-September, 2004 outcome is revised.
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 F) and net foreign assets (as defined in section A), with the latter being converted from U.S. dollars into dinars at the program exchange rates 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 December 2004, of March, June, September, and December 2005, 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 September 30, 2004, NDA of the NBS so defined were valued at CSD -21,924 million (Annex B).
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 CSD 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 programmed annual 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 F), supplied to the European 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 program 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 and commercial banks licensed by it in Serbia, as well as the CBM and commercial banks licensed by it in Montenegro. The consolidated general government was defined above.
11. Reporting. The ceilings will be monitored using end-month data on the accounts of the banking system supplied to the European 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 the end-December 2003 outcome is revised. 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 CSD 5 billion for Serbia's and €6 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, and from asset sales by the public sector and by state-owned or socially-owned enterprises. 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 the year specified) with the actual inflows evaluated at the average exchange rates of the month when funds are received:
Serbia (2004, in billions of dinars)
Serbia (2005, in billions of dinars)
Montenegro (2004, in € million)
Montenegro (2005, in € million)
D. Nonbank Domestic Financing
13. Definition. Nonbank domestic financing to the consolidated general government is defined as any form of resident financing for the consolidated budget deficit other than (i) from the NBS, (ii) from commercial banks, and (iii) privatization proceeds. This will include domestic financing from nonbank financial institutions, nonfinancial enterprises, households, and all other domestic financing not elsewhere classified. Nonbank domestic financing covers any net change in the consolidated general government liabilities to any of these institutions, representing either direct loans or advances to the consolidated general government or holdings of securities of the consolidated general government, including promissory notes or other contractual obligations. FFCD payments are treated below the line as negative domestic nonbank financing.
14. Adjustor: if quarterly net nonbank domestic financing deviates from the projected quarterly cumulative path (coinciding with projected cumulative FFCD payments) provided below in billions of dinars, the excess (shortfall) will trigger an equal downward (upward) adjustment in (i) net banking system credit to the consolidated general government (performance criterion) and in (ii) net banking system credit to the consolidated general government in Serbia (indicative target).
E. Ceiling on Change in Domestic Arrears
15. 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.
17. 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 Department of the Fund by the Ministry of Finance of Serbia, and the Ministry of Finance of Montenegro.
F. Definition of Reserve Money
18. 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. As of September 30, 2004, the required reserve ratio was at 21 percent of the base as defined in NBS Decision of March 28, 2002. 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 (CSD 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 above required reserves on account 201 at the NBS (with the shortfall in required reserves counted as negative excess); and (4) cash in vaults.
19. Data on reserve money will be monitored from the daily monetary indicators of the NBS, which will be supplied to the European 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 will be provided to the Fund with a lag of less than three weeks. On September 30, 2004, currency in circulation amounted to CSD 42,463 million, while required reserves amounted to CSD18,738 million, and excess reserves to CSD 2,934 million. For program and projection purposes, monthly averages of reserve money and its components were used. Data on effective reserve requirements and the deposit base used in reserve requirement calculations will be supplied to the European Department on a ten-day basis with a lag of less than a week.
20. Adjustors. For program monitoring purposes, reserve money will be adjusted as follows. Should the standard reserve requirement increase (decrease) from the level prevailing on September 30, 2004, the ceiling on net domestic assets would be increased (decreased) by an amount equivalent to the change in the standard reserve requirement ratio multiplied by the programmed deposit base used in the calculation of required reserves. Before making any 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. Similarly, the CBM will consult with Fund staff before making any changes to the reserve requirement.
G. Ceiling on External Debt-Service Arrears
21. 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.
22. 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.
H. Ceilings on External Debt
23. 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. However, in 2004 cumulative from December 31, 2003, contracting or guaranteeing by the public sector of new nonconcessional external debt from the EBRD, the EIB and EU, the IBRD, and the IFC will not exceed US$500 million by end-June 2004, US$500 million by end-September 2004, and US$500 million by end-December 2004 (Annex A defines the separate ceilings applicable for Serbia and for Montenegro). In 2005 cumulative from December 31, 2004, contracting or guaranteeing by the public sector of new nonconcessional external debt from the EBRD, the EIB and EU, the IBRD, and the IFC will not exceed US$100 million by end-March 2005, US$200 million by end-June 2005, US$300 million by end-September 2005, and US$400 million by end-December 2005 (Annex A defines the separate ceilings applicable for Serbia and for Montenegro).Contracting or guaranteeing of new debt will be converted into US$ for program purposes at the cross exchange rates implied by the official NBS exchange rates in effect on the day of the transaction. 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.
24. 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, separately by Serbia and Montenegro, within four weeks of the end of each quarter.
I. Ceiling on the Wage Bill of Serbian Public Enterprises
25. Definition. For December 2004, the performance criterion is set on the total annual wage bill of seven large public enterprises: JP Elektroprivreda Srbije, JP Naftna Industrija Srbije, JP Zeleznicko Transportno Preduzece Srbije, JP PTT Srbije, JP Srbija Sume, JP JAT Airways, and JP Telekom Srbija. For 2005, the performance criterion is set on a quarterly basis on the cumulative monthly wage bill of eight large public enterprises (the same seven enterprises as in 2004 plus JP Aerodrom Beograd). Wages are accounted on an accrual basis, excluding taxes and social security contributions, and include overtime payments and bonuses. Ceilings for end-December 2004 and for end-March 2005 are performance criteria set in the Fourth Review.
26. Adjustors. In the case of spin-offs of activities from these companies (defined as the spinning off of a unit or its transfer to another entity or temporary/permanent transfers of employees) after end-September 2004, the wage bill target will be adjusted downwards for the wage bills of spun-off units. In the case of EPS, the successor companies (according to MEFP paragraph 35, bullet two) will all be included in the wage ceiling.
27. Reporting. The wage bills of the eight monitored state-owned companies will be reported monthly to the European Department of the Fund and the Office of the IMF Resident Representative by the Ministry of Finance (Public Utility Restructuring Unit) with a lag of less than four weeks. Monthly data for JP Aerodrom Beograd will also be provided for the period January through December 2004.
Serbia (In CSD millions)
J. Adjustor for Lower-Than-Targeted Severance Payments
28. Within the overall expenditure envelope of the 2005 budgets for the central government in Serbia, the Union level government, and the Serbian Transition Fund a total amount of CSD 8.2 billion is envisaged for severance payments, out of which (a) CSD 5.0 billion related to employment reduction in the Serbian central government; (b) CSD 2.0 billion related to employment reduction on the Union level; and (c) CSD 1.2 billion included in the funds for the Transition Fund related to employment reduction in the eight monitored state-owned enterprises listed in paragraph 24 of the TMU. While the expenditures under (a) and (b) will be financed through general budgetary revenue, expenditures under (c) will financed through privatization receipts. To ensure that these budgetary resources can be spent only for the intended severance payments, the ceiling on net credit of the banking system to the consolidated general government (performance criterion) and on net credit of the banking system to the Serbian consolidated general government (indicative target) will be adjusted downwards for the total shortfall of the respective severance expenditures in categories (a), (b), and (c).
III. Other Reporting Requirements for Program Monitoring
A. Macroeconomic Monitoring Committee
29. A macroeconomic monitoring committee, composed of senior officials from the Union Government, Serbian and Montenegrin Ministries of Finance, the NBS, CBM, 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
30. The authorities will notify the European Department of the Fund of developments on structural performance criteria and benchmarks as soon as they occur. The authorities will provide the documentation, according to the dates in Annex C, elaborating on policy implementation. The authorities will also notify the European Department of the Fund expeditiously of any economic developments or policy measures (prior to taking such measures in the latter case) that could have a significant impact on the implementation of this program.
C. Data Reporting
Production and prices
31. Any revision to relevant macroeconomic data will be transmitted within three weeks of the date of the revision.
32. Monthly data on public finance will include a consolidated budget report of the state governments (including union level operations), transmitted within four weeks of the end of each month comprising:
Monetary sector data
33. The following data will be transmitted on a daily/weekly/biweekly basis within one/five working days of the end of each day/week.
34. The balance sheet of the NBS and the consolidated balance sheets of Serbian commercial banks, as well as the balance sheet of the Central Bank of Montenegro and the consolidated balance sheets of commercial banks in Montenegro, will be transmitted on a monthly basis within three weeks after the end of each month. The stocks of government and NBS securities held by banks and by nonbanks, 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 after the end of each month. Credit to government by the banking system is provided with detailed breakdowns on the union, state, and local governments.
35. The following data will be transmitted on a monthly basis:
36. The data below will be transmitted as follows:
1Annex A, attached to this memorandum, contains the quantitative performance criteria and indicative targets, while Annexes B and C list the structural performance criteria and benchmarks as well as prior actions. Annex D (Technical Memorandum of Understanding, TMU) defines the performance criteria and indicative targets and describes the reporting arrangements.
2In terms of Serbian GDP, the consolidated Serbian fiscal deficit is projected to decline from 3.2 percent of GDP in 2003 to 1.9 percent of GDP in 2004 (from 2.7 percent to 1.3 percent excluding FLFPs).
3In terms of Serbian GDP, the overall deficit will be cut by 1.3 percent of GDP in 2005 to 0.6 percent of GDP in 2005 (a surplus of 0.1 percent excluding FLFPs).
4The number of monitored enterprises increases to 8 from January 1, 2005 (see paragraph 24 of the TMU).