## _cr05393 ## Source details **Canonical URL:** [_cr05393](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05393.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05393.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05393.pdf.json) --- ### Political background and program stance - President Mesa resigned; Eduardo Rodríguez (President of the Supreme Court) became interim President on June 9. - Constitution amended to allow early general elections on December 4, 2005; new president to take office on January 22, 2006. - Given the interim mandate, the structural component of the Stand-By Arrangement (SBA) is being reprofiled and access to the SBA reduced and rephased; authorities intend to treat the SBA as precautionary. - Requests to the Fund include: - One waiver of nonobservance of a structural performance criterion for June 2005. - Waivers of applicability for two end-September performance criteria (pending final combined public sector deficit and domestic financing outturns). - Reduce total access under the SBA by SDR 25.72 million (15 percent of quota) and rephase remaining SDR 17.14 million (10 percent of quota). - Completion of the seventh review contingent on observance of end-December 2005 performance criteria and assessment of policies of the new government. ### 2005 macroeconomic performance and outlook - Real GDP growth: - Staff projection for 2005: growth of 3.9 percent (compared to 3.6 percent in 2004). - Prel. 2005: 4.5 (table value); Prog. 2005: 3.9; Proj. 2006: 4.1. - Authorities expect real GDP growth for 2005 to be around 4 percent. - Inflation: - Twelve-month inflation projected at 4.2 percent (June peak was 6.4 percent). - Program inflation target: 3.8 percent. - CPI inflation table: Prel. 2005: 4.7; Prog. 2005: 5.3; Proj. 2006: 3.4. - Balance of payments and reserves: - Balance of payments substantially stronger than programmed; current account surplus broadly in line with program. - Net international reserves (NIR) projected to increase by US$230 million (programmed increase was US$40 million). - End-December 2005 floor on NIR accumulation agreed at US$135 million (mid-point between original target and current projection). - Gross international reserves (end-of-period, US$ millions): Prel. 2005: 1,426; Prog. 2005: 1,614; Proj. 2006: 1,636. - Monetary aggregates and credit: - Broad money (percent change): Prel. 2005: 9.1; Prog. 2005: 13.3; Proj. 2006: 8.7. - Credit to private sector (percent change): Prel. 2005: 7.7; Prog. 2005: 3.8; Proj. 2006: 3.6. ### Fiscal developments, 2005 and 2006 framework - Fiscal trajectory: - Fiscal deficit peak nearly 9 percent of GDP in 2002 to 3.5 percent of GDP in 2005. - 2005 fiscal deficit projected at Bs 2,728 million (3.5 percent of GDP), compared with original program target of Bs 3,763 million (4.8 percent of GDP). - Ratios based on programmed GDP would correspond to 3.7 and 5.2 percent, respectively. - 2005 outcomes: - Combined public sector overall surplus in first seven months of 2005: 0.4 percent of GDP. - Table 2 (operations of the combined public sector, in millions of bolivianos): Revenue and grants (2005 Prel.): 13,520; Current revenue (2005 Prel.): 12,142; Total spending (2005 Prel.): 17,189; Overall balance (deficit) (2005 Prel.): -3,668; Public Debt (2005 Prel., millions of bolivianos): 32,346; Nominal GDP (2005 Prel.): 53,790. - 2006 budget and policy stance: - Fiscal deficit expected to decline to 3 percent in 2006 by saving part of the increase in hydrocarbons revenue and prudently managing current spending. - Government proposed limit on deficit of combined public sector: 3.7 percent of GDP; based on staff revenue projection and assuming 93 percent implementation rate of investment budget, consistent with fiscal deficit outturn of 3.0 percent of GDP. - Revenue projection includes elimination of the financial transactions tax (FTT) on local currency sight deposits; FTT on foreign currency sight and savings deposits to be maintained. - Fuel subsidies could surpass one percent of GDP in 2006 (from 0.8 percent of GDP in 2005). - Royalties on hydrocarbons (percent of GDP): Prel. 2005: 3.7; Prog. 2005: 5.4; Proj. 2006: 6.7. ### Monetary policy, exchange rate, and financial sector measures - Central Bank action: - BCB tightened monetary policy in May/June, raising repo rates by over 100 basis points in response to large deposit withdrawals; repo rates later reduced as deposits recovered. - BCB stepped up open market operations to sterilize monetary impact of large external inflows and target reduction in 12-month growth in currency issue (take action to reduce from over 30 percent in June to 26 percent by December 2005). - Reserves and liquidity: - Financial system deposits recovered; liquidity assistance to banks fully repaid. - Projected increase in financial system liquid foreign asset coverage of deposits to around 54 percent. - De-dollarization and reserve requirements: - Authorities raised average and marginal reserve requirements on dollar deposits (starting April 2005) to continue de-dollarization. - Dollarization indicators (end-period stocks): Foreign currency deposits (percent of total deposits): Prel. 2005: 84.0; Prog. 2005: 83.4. Foreign currency credit (percent of total loans): Prel. 2005: 95.9; Prog. 2005: 95.4. - Exchange rate policy: - BCB maintained bilateral exchange rate of the Boliviano virtually unchanged against the U.S. dollar since end-2004; marginal appreciations in July and mid-September under the crawling peg and a slightly widened buy-sell spread. - Authorities are not considering changes in the exchange rate regime at this stage but staff encourages gradual move to greater exchange rate flexibility. ### Structural reforms, hydrocarbon sector, and privatization - Hydrocarbons law (May 2005): - Introduced Impuesto Directo a los Hidrocarburos (IDH), a production-based tax; together with existing royalties implies a flat production-based tax rate of 50 percent for all fields. - Expanded role of YPFB to intermediate all contracts to export natural gas and become the only importer and wholesale distributor of fuel products. - Mandatory migration to new contracts imposed on energy companies. - Private sector reaction: sharply negative; companies considering international arbitration. - Mission noted risks: tax rate rigidities, legal uncertainties, reduced central government share of revenues while retaining most spending responsibilities. - Petroleum product pricing (Box 1): - Domestic crude oil price frozen at US$27 per barrel. - December 2004: domestic petroleum product prices raised by an average of 10 percent for major products; prices remained unchanged since. - Excise taxes on petroleum products: declined from 2.6 percent of GDP in 2000 to 1.6 percent of GDP in 2004; estimated excise tax yield of 2.4 percent of GDP in 2005 after December 2004 increase. - Diesel and LPG domestic prices set substantially below import and production costs; diesel subsidies projected to reach close to 1 percent of GDP in 2006. - PSIA recommended more flexibility in fuel prices and protection measures for vulnerable groups. - Financial sector reforms and FRF: - Tightened provisioning and loan classification rules imply US$ 57 million additional provisions (a 21 percent increase on average), US$ 45 million to be constituted over three years. - FRF established as legal entity; Central Bank’s liquidity contribution on behalf of the Treasury extended through end-2005 to allow FRF to build resources. - Proposed deposit insurance reform: under current law FRF can contribute up to 30 percent of covered deposits for P&A; proposed bill would have FRF cover deposits up to a pre-established ceiling such that over 90 percent of depositors would be protected. - Performance criterion to divest remainder of the state’s assets in banks where public sector holds majority ownership maintained (sale by end-year planned). ### Medium-term outlook (2006–10) and scenarios - Growth and revenue assumptions: - Updated medium-term outlook incorporates a broadly flat path for natural gas production and export volumes because new hydrocarbons law expected to discourage new large investment. - Over 2006–10, higher tax rates and upward revision of gas export prices reflected in higher annual hydrocarbons-based fiscal revenue by about 1 percentage point of GDP relative to the medium-term scenario presented in March for the fifth review. - Medium-term real GDP growth projections: 2007: 3.9; 2008: 3.0; 2009: 3.0; 2010: 3.0. - Debt and fiscal projections: - Baseline assumption: broadly unchanged natural gas production and export volumes through 2015. - NPV of nonfinancial public sector debt to GDP declines from about 55 percent in 2004 to 44 percent by 2015 (Table 10 baseline: 2004: 55; 2005: 54; 2006: 54; 2015: 44). - Main risks: - Larger-than-projected fall in energy prices. - Potential expenditure pressures at subnational level driven by increased hydrocarbons-based revenue and increase in regional share from 45 percent to 65 percent without corresponding spending responsibilities. - Staff recommendation: develop a more balanced distribution of expenditure responsibilities among all levels of government. ### Debt sustainability and stress tests - Stress test outcomes (selected): - Permanent decline in hydrocarbons-based revenue (~20 percent on average for 2006–10) raises NPV/GDP ratio by about 7 percentage points (51 percent in 2015) but declining trend maintained. - Bolivia would withstand relatively well an increase in interest rates or higher share of nonconcessional financing. - A 30 percent devaluation in 2006 would increase NPV/GDP ratio initially to 76 percent, effects diminish over time. - If primary balance remains unchanged at projected 2005 level (deficit of 0.5 percent of GDP), NPV/GDP ratio would remain virtually unchanged, declining marginally to 53 percent by 2015. - Stress test scenarios include: - A1. Lower oil prices (US$15 below baseline in 2006 and US$10 below thereafter). - A2. Higher nonconcessional financing (increase by 1.2 percent on average in 2007–2015). - A3. Higher interest rates on nonconcessional borrowing (300 basis points increase). - A4. One time 30 percent devaluation in 2005. - A5. Primary balance unchanged starting 2005. ### Program conditionality, performance, and reporting - All end-June 2005 quantitative performance criteria were observed; authorities expect to have met all end-September 2005 quantitative performance criteria with margins (pending final data on combined public sector deficit and domestic financing). - Waiver requested and recommended by staff for nonobservance of end-June 2005 structural performance criterion on passage of a revised 2005 budget law. - Proposed modifications to end-December 2005 quantitative performance criteria: tighter targets for fiscal deficit, net credit from the BCB to the nonfinancial public sector, and NIR and NDA of the BCB. - Reporting requirements: - Monthly updates for fiscal and monetary information at most 25 calendar days after month end. - Treasury to remit weekly information on all placements of treasury bonds other than open market operations. - Quarterly estimate of pro-poor spending provided at most 90 calendar days after quarter end. ### Vulnerabilities and staff recommendations - Key vulnerabilities: - Highly dollarized financial system subject to deposit runs; FX deposits held by residents (percent of total deposits): 85.2 (August); FX loans to residents (percent of total loans): 94.5 (August). - Uncertainty surrounding investment climate after passage of new hydrocarbons law. - Fiscal position sensitive to revenue/expenditure-sharing arrangements between central and subnational governments. - Political uncertainties associated with transition and forthcoming elections. - Financial sector health indicators (July): - Capital adequacy ratio: 14.8; NPLs in percent of total loans: 14.3; Provisions in percent of NPLs: 73.7; Return on average assets: 0.2; Return on equity: 1.9. - Key staff recommendations: - Sustain better-than-programmed fiscal position and continue firm control of the deficit. - Correct distortions in the hydrocarbons law promptly, including possible interim arrangements with companies. - Pursue approval of the Budget Framework Law and finalize a revenue-neutral tax reform anchored on efficiency and equity; personal income tax should exempt low-income households. - Implement more timely petroleum product price adjustments and target subsidies to the most vulnerable. - Continue strengthening debt structure and reduce vulnerability. - Maintain vigilance over the financial system and complete reforms (deposit insurance law, corporate restructuring and bankruptcy reform). - Consider gradual move toward greater exchange rate flexibility. - Advance PRSP technical work and deepen pro-poor public expenditure. *Source: IMF staff report (document _cr05393).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Political background and program stance - President Mesa resigned; Eduardo Rodríguez (President of the Supreme Court) became interim President on June 9. - Constitution amended to allow early general elections on December 4, 2005, and, for the first time, elections of regional governors. The new president will take over on January 22, 2006. - Given the interim mandate of the authorities, the structural component of the Stand-By Arrangement (SBA) program is being reprofiled and access to the SBA reduced and rephased; the authorities intend to treat the SBA as precautionary. ### Macroeconomic performance and outlook for 2005 - Real GDP growth for 2005 is expected to be around 4 percent. - Staff projection for 2005: growth of 3.9 percent (compared to 3.6 percent in 2004). - Twelve-month inflation projected at 4.2 percent (June peak was 6.4 percent). - Program inflation target: 3.8 percent. - External current account continues to record a substantial surplus. - Balance of payments projected to be substantially stronger than programmed; net international reserves (NIR) projected to increase by US$230 million (programmed increase was US$40 million). - End-December 2005 floor on NIR accumulation agreed at US$135 million (mid-point between the original target and the current projection). ### Fiscal developments and targets - Fiscal deficit trajectory: peak of nearly 9 percent of GDP in 2002 to 3.5 percent of GDP in 2005. - Combined public sector overall surplus in the first seven months of 2005: 0.4 percent of GDP. - 2005 fiscal deficit projected at Bs 2,728 million (3.5 percent of GDP), compared with the original program target of Bs 3,763 million (4.8 percent of GDP). - Ratios based on programmed GDP would correspond to 3.7 and 5.2 percent, respectively. - Fiscal policy for 2006: fiscal deficit expected to decline to 3 percent in 2006 by saving part of the increase in hydrocarbons revenue and prudently managing current spending. - Prior actions for the sixth review: submission to congress of a 2006 budget proposal in line with the agreed target; submission to congress of the budget framework and deposit insurance laws. ### Monetary policy, reserves, and financial sector - Central Bank of Bolivia (BCB) tightened monetary policy during May/June, raising repo rates by over 100 basis points in response to large deposit withdrawals; repo rates later reduced as deposits recovered. - Financial system deposits recovered; liquidity assistance to banks fully repaid. - NIR and central bank reserves strengthened substantially and well above original program targets; projected increase in financial system liquid foreign asset coverage of deposits to around 54 percent. - Authorities raised average and marginal reserve requirements on dollar deposits (starting April 2005) to continue de-dollarization. - Through open market operations, the share of local currency treasury paper increased by over 20 percentage points since end-2004; average maturity of newly issued treasury paper tripled to over three years. - BCB stepped up open market operations to sterilize the monetary impact of large external inflows and to target a substantial reduction in the 12-month growth in currency issue. ### Exchange rate policy - The BCB has maintained the bilateral exchange rate of the Boliviano virtually unchanged against the U.S. dollar since end-2004, implying a highly competitive real effective exchange rate given appreciation of regional currencies. - In July and mid-September, the BCB marginally appreciated the Boliviano under the crawling peg and widened the buy-sell spread slightly; increased interbank FX market activity observed. - Authorities are not considering changes in the exchange rate regime at this stage. ### Structural reforms and program reprofiling - Structural policy implementation suffered setbacks, notably in the hydrocarbons sector; the new hydrocarbons law is likely to discourage investment. - Given limited mandate of the interim government, authorities propose scaling down and rephasing the structural reform agenda for 2005, particularly in tax policy. - Program adjustments: macroeconomic program for 2005 strengthened (fiscal deficit limit set at 3.5 percent of GDP, compared with the original target), higher NIR accumulation floor (US$135 million), and higher liquid foreign asset coverage target of financial system deposits (54 percent). Access to the SBA reduced and rephased. ### Vulnerabilities and policy implications - Key vulnerabilities: - Highly dollarized financial system subject to deposit runs. - Uncertainty surrounding the investment climate after passage of the new hydrocarbons law. - Fiscal position sensitive to revenue/expenditure-sharing arrangements between central and subnational governments. - Political uncertainties associated with the transition and forthcoming elections. - The program is viewed as a critical anchor for policy during the political transition, providing continuity and a framework for maintaining macroeconomic stability and preparing for further essential structural reforms. *Source: Executive Summary (IMF staff report).* ### 10. The balance of payments has been substantially stronger than programmed. ### 10. The balance of payments has been substantially stronger than programmed. ### Balance of payments and reserves - Exports benefited from high energy and metals prices; current account surplus has been broadly in line with the program despite supply disruptions in the first half of the year. - Capital and financial account recorded a higher-than-projected surplus despite a shortfall in disbursements of external loans for public investment projects. - Higher-than-programmed demand for Bolivianos and direct foreign investments in the mining sector helped bolster the capital and financial account. - Overall effect: a higher-than-programmed level of international reserves. ### Preliminary macroeconomic framework for 2006 - Authorities envisage for 2006: - Real GDP growth in the range of 4–4½ percent. - Lower inflation. - Further reduction of financial sector vulnerabilities. - Growth assumption drivers: - Acceleration in mining and construction reflecting large ongoing mining investments. - Higher capacity utilization in the hydrocarbons sector. - Policy stance to support lower inflation and external balances: - Prudent management of the revenue windfall from the hydrocarbons sector; a significant portion to be saved to reduce the fiscal deficit and avoid expenditure rigidities. - Proposed fiscal stance and a competitive exchange rate, together with strong prices for hydrocarbons and mining exports, expected to maintain sizable current account and overall balance of payments surpluses and further increase reserve coverage of financial sector deposits. - Government fiscal intentions for 2006: - Submit a 2006 budget consistent with a further reduction in the fiscal deficit to 3.0 percent of GDP. - Predicated on an increase in tax revenue by about 0.5 percent of GDP, as higher hydrocarbon royalties and IDH (production) taxes would compensate for a decline in corporate income tax from the hydrocarbon sector. - Revenue projection includes elimination of the financial transactions tax (FTT) on local currency sight deposits; the FTT on foreign currency sight and savings deposits will be maintained at the current rate. - Total public investment (including by subnational governments) expected to increase in relation to GDP; current spending to be contained, including the wage bill; further reduction in pension costs expected. - Fuel subsidies could surpass one percent of GDP in 2006 (from 0.8 percent of GDP in 2005). - Government’s proposed limit on the deficit of the combined public sector: 3.7 percent of GDP; based on Fund staff revenue projection and assuming an implementation rate of 93 percent of the investment budget, consistent with a fiscal deficit outturn of 3.0 percent of GDP. ### Structural reforms — fiscal and financial - Fiscal progress: - Congress elevated to law the new tax code procedures. - Financial sector progress: - Provisioning and reserve requirements tightened. - Congress approved a law establishing the Financial Restructuring Fund (FRF) as a legal entity and enhancing the autonomy of the banking superintendency and the central bank. - Authorities’ concerns and stance on hydrocarbons law: - Mission expressed concern about the hydrocarbons law enacted by congress in May; authorities do not envisage further changes to the legal framework at this stage and plan to implement and regulate the law as mandated. - The mission noted the new hydrocarbons regime risks undermining future sector development because of tax rate rigidities and legal uncertainties. - Planned reform actions (selected): - Fiscal: - Submit draft budget framework law to congress (prior action). - Prepare draft tax reform bill, including a personal income tax, for consideration by the new government (December 2005 benchmark). - Advance registry of all public sector employees and pensioners and a registry system on subnational debt (December 2005 benchmark). - Financial: - Submit draft law introducing a partial coverage deposit insurance scheme to congress (prior action). - Submit draft legislation to improve corporate restructuring and bankruptcy framework (December 2005 benchmark). - Divest remainder of the state’s assets in banks where the public sector holds majority ownership (December performance criterion to be maintained). ### Petroleum product pricing (Box 1) — key findings - Domestic petroleum product prices are set administratively and mostly have not reflected international price changes in recent years. - December 2004: domestic petroleum product prices raised by an average of 10 percent for major products; prices have remained unchanged since. - Excise tax yield dynamics: - Excise taxes on petroleum products declined from 2.6 percent of GDP in 2000 to 1.6 percent of GDP in 2004. - The December 2004 increase is reflected in an estimated excise tax yield of 2.4 percent of GDP in 2005. - Price controls and implicit subsidies: - Domestic crude oil price is frozen at US$27 per barrel, which keeps petroleum product cost structure artificially low. - Diesel and LPG domestic prices set substantially below import and production costs, creating an explicit subsidy in the budget. - Diesel imports account for about one-third of domestic consumption; diesel subsidies projected to reach close to 1 percent of GDP in 2006. - Low domestic prices have led to smuggling of LPG and diesel to neighboring countries. - Social impact: - Pricing policy is regressive; benefits are captured predominantly by higher income groups. - PSIA recommended more flexibility in fuel prices, and that substantial increases (particularly for LPG) should be accompanied by measures to protect vulnerable groups. ### New hydrocarbons regime (Box 2) — key features and risks - May 2005 law introduced sharp changes consistent with a mid-2004 referendum. - Main changes: - Introduced Impuesto Directo a los Hidrocarburos (IDH), a production-based tax; together with existing royalties implies a flat production-based tax rate of 50 percent for all fields. - Expanded role of YPFB to intermediate all contracts to export natural gas and become the only importer and wholesale distributor of fuel products, and a more active market participant and regulator. - Mandatory migration to new contracts imposed on energy companies operating in Bolivia. - Private sector reaction: - Sharply negative; companies are considering international arbitration, especially over the migration provision. - Companies argue that the new tax system and expanded YPFB role may undermine prospects for additional investment in the hydrocarbons sector. - Fiscal management implications: - Revenue sharing provisions reduce the central government’s share of revenues while central government retains most spending responsibilities; likely to create regional spending rigidities and medium-term fiscal management challenges. ### Financial sector reforms in 2005 (Box 3) — key figures and measures - Tightened provisioning and loan classification rules imply US$ 57 million additional provisions (a 21 percent increase on average), of which US$ 45 million are to be constituted over three years; some banks may constitute these immediately. - Increase in average reserve requirements of 2 percentage points on dollar deposits in April 2005 and subsequent increases on marginal reserve requirements have helped increase reserve coverage of deposits and encouraged de-dollarization. - Strengthened SBEF capacity and bank resolution framework: - FRF established as legal entity; Central Bank’s liquidity contribution on behalf of the Treasury extended through end-2005 to allow the FRF to build resources. - Proposed deposit insurance reform: - Under current law the FRF can contribute up to 30 percent of covered deposits for purchase and assumption (P&A); proposed bill would have the FRF cover deposits up to a pre-established ceiling such that over 90 percent of depositors would be protected. - Corporate restructuring and bankruptcy framework weaknesses identified; draft legislation to be submitted to congress by year end. ### Medium-term outlook (2006–10) and scenarios - Updated medium-term outlook incorporates a broadly flat path for natural gas production and export volumes because the new hydrocarbons law is expected to discourage new large investment in the hydrocarbons sector over the medium term. - Fiscal prospects improved for the next five years due to higher hydrocarbons taxation, stronger commodity prices, and envisaged tax reform: - Over 2006–10, higher tax rates and upward revision of gas export prices reflected in higher annual hydrocarbons-based fiscal revenue by about 1 percentage point of GDP relative to the medium-term scenario presented in March for the fifth review. - Enlarged revenue envelope allows a more upfront reduction in the fiscal deficit and a more rapid reduction in the debt ratio without undermining poverty-reduction and growth efforts. - Main risks: - Larger-than-projected fall in energy prices. - Potential expenditure pressures at subnational level driven by increased hydrocarbons-based revenue and increased regional share from 45 percent to 65 percent without corresponding spending responsibilities; risk of spending rigidities. - Staff recommendation: develop a more balanced distribution of expenditure responsibilities among all levels of government. ### Debt sustainability analysis - Baseline assumption: continuation of broadly unchanged natural gas production and export volumes through 2015. - Debt path implications: - Ratio of the NPV of the nonfinancial public sector debt to GDP declines from about 55 percent in 2004 to 44 percent by 2015. - Stress test outcomes: - A permanent decline in hydrocarbons-based revenue (of about 20 percent on average for 2006–10) results in an NPV/GDP ratio about 7 percent points higher (51 percent in 2015), but the declining trend is maintained. - Bolivia would withstand relatively well an increase in interest rates or an increase in the share of nonconcessional financing. - A 30 percent devaluation in 2006 would lead to an initial sharp increase in the NPV/GDP ratio (to 76 percent), but the effects would diminish over time. - If the primary balance remains unchanged at the projected 2005 level (a deficit of 0.5 percent of GDP), the NPV/GDP ratio would remain virtually unchanged, declining only marginally to 53 percent by 2015; this underlines the need for fiscal adjustment over the medium term as assumed in the baseline. *Source: IMF staff report (chapter content provided).* ### 20. In the attached Letter of Intent (LOI) and Memorandum on Economic and ### 20. In the attached Letter of Intent (LOI) and Memorandum on Economic and Financial Policies (MEFP) ### Program requests, conditionality, and access - Authorities request completion of the sixth review and describe supporting policies. - Requests include: - One waiver of nonobservance of a structural performance criterion for June 2005. - Waivers of applicability for two end-September performance criteria (pending final combined public sector deficit and domestic financing outturns). - Modification: one end-December 2005 structural performance criterion converted into a structural benchmark. - Modification of several structural benchmarks. - Prior actions required for Executive Board consideration of the sixth review: - Submission to congress of (i) the 2006 budget; (ii) the budget framework law; and (iii) the law creating a partial deposit insurance scheme (LOI ¶ 5, MEFP ¶ 12 and ¶ 15, and MEFP Table 2). - Completion of the seventh review is contingent on: - Observance of end-December 2005 performance criteria (LOI ¶ 5 and MEFP Tables 1 and 2). - An assessment of the direction of policies of the new government. - Proposed treatment and rephasing of SBA access: - Reduce total access under the SBA by SDR 25.72 million (15 percent of quota), corresponding to the last currently scheduled purchase. - Rephase remaining SDR 17.14 million (10 percent of quota), available after the purchase associated with this sixth review, and link it to the next and final review. - Treat the arrangement as precautionary (Table 8 and LOI ¶ 5). - Seventh review discussions to allow the next government to outline medium-term economic policies and poverty reduction strategy, including intentions regarding relations with the Fund and implications of the G-8 debt cancellation initiative (LOI ¶ 5). ### Performance against quantitative and structural criteria - All end-June 2005 quantitative performance criteria were observed: - Fiscal deficit was smaller than programmed. - Net international reserves (NIR) target met with a large margin (LOI ¶ 2, MEFP ¶ 2, and MEFP Table 1). - Authorities expect to have met all quantitative performance criteria for end-September 2005 with margins, but final combined public sector deficit and domestic financing data are pending; waivers of applicability requested for those performance criteria. - Waiver requested for nonobservance of the end-June 2005 structural performance criterion on passage of a revised 2005 budget law (LOI ¶ 3 and MEFP Table 2). - Staff recommends granting the waiver given expected observance of original fiscal program objectives with a margin and a correspondingly tighter current fiscal program. - Authorities propose modifications to end-December 2005 quantitative performance criteria: - Tighter targets for the fiscal deficit, net credit from the BCB to the nonfinancial public sector, and the net international reserves and net domestic assets of the BCB (LOI ¶ 3, MEFP ¶ 9 and ¶ 10, and MEFP Table 1). - Proposed modifications to structural conditionality for the seventh review: - Conversion of the end-December 2005 performance criterion on approval of the 2006 budget to a benchmark, due to higher uncertainty about congress’s ability to complete consideration before year-end (LOI ¶ 4, MEFP ¶ 15, MEFP Table 2). - Authorities expect to submit the budget to congress in time to benefit from the constitutional provision allowing lapse-of-time approval of the budget proposal. ### Fiscal outcomes, projections, and policy implications - Fiscal position developments: - Much better-than-programmed fiscal position helped monetary developments. - Proposed tightening of the fiscal deficit target for 2005 is highlighted as evidence of commitment to prudent fiscal management. - 2006 budget proposal: - Consistent with a reduction in the fiscal deficit to 3 percent of GDP, based on staff revenue projections and assumptions on the rate of execution of the capital budget. - Achievement requires continued strict control over current expenditure. - Underpinned by specific agreements between central and subnational governments on revenue sharing and spending responsibilities during 2006. - Historical context: - Fiscal deficit had a very high recent peak of nearly 9 percent of GDP in 2002. - Hydrocarbons sector and revenue risks: - Budgetary revenue likely to benefit from the new hydrocarbons law for several years. - Design of the law raises concerns about rigidities and uncertainties that could adversely affect sector development. - Specific concerns: - Need for more flexibility in effective tax rates to account for diverse profitability and changes in international oil and gas prices. - Need to overcome legal issues around mandatory “migration” to new contracts. - Authorities urged to correct distortions promptly, including through mutually acceptable interim arrangements within the current legal framework, to avoid jeopardizing investment, growth prospects, and long-term fiscal sustainability. - Fiscal reform advice: - Staff attaches critical importance to work on a tax reform proposal for the next government that should be at least revenue neutral and anchored on principles of efficiency and equity. - Personal income tax component should be designed to exempt low-income households. - Staff urges more timely adjustments to petroleum product prices to reduce allocative distortions and budgetary cost, make pricing responsive to market conditions, and direct limited subsidies to the most vulnerable groups. - Reforms suggested to cushion expected loss of revenue from the FTT, which the authorities are encouraged to remove as soon as possible. ### Monetary, exchange rate, and financial sector developments - Monetary policy and reserves: - Central bank implemented a timely and measured monetary response balancing tighter conditions and liquidity provision to banks facing deposit withdrawals. - After sentiment improved, authorities rebuilt international reserves while partially sterilizing monetary impact through stepped up open market operations. - Outcomes achieved amid a decline in policy interest rates and significant improvement in maturity structure and currency composition of domestic debt. - Further progress in strengthening debt structure is important to reduce vulnerability. - Exchange rate regime: - Crawling peg regime has served Bolivia well and contributed to stronger-than-programmed balance of payments performance in 2005. - Allowed maintenance of competitive exchange rate through small discrete nominal adjustments while keeping balance sheet effects manageable in a highly dollarized environment. - System not flexible enough for agile response to shocks and contributes to persistent dollarization. - Authorities encouraged to consider a gradual move to a greater degree of exchange rate flexibility. - Financial sector reforms and vulnerabilities: - Staff welcomes increased reserve requirements, new tighter norms on provisioning, and enhanced autonomy of the central bank and the superintendency of financial institutions. - Approval of the new deposit insurance law to be submitted to congress would help reduce financial system vulnerabilities. - Authorities encouraged to submit, by the end of the year as committed, a legislative proposal to reform corporate restructuring and bankruptcy framework. ### Structural reforms, decentralization, and poverty reduction - Structural progress: - Important progress made in a challenging political and social environment. - Fiscal area: strengthened tax enforcement via enactment of revised tax code procedures. - Budget framework law: - Staff urges pursuit of approval of the soon-to-be-submitted budget framework law to improve preparation and implementation of the budget. - Fiscal decentralization challenge: - Over the medium term, reconcile domestic calls for increased fiscal decentralization and regional autonomy with need to ensure revenue sharing and expenditure assignments are consistent with fiscal consolidation and efficient public spending. - Authorities encouraged to build on international best practices; staff stands ready to provide technical assistance. - Poverty reduction strategy: - Current government cannot update Bolivia’s medium-term PRSP or complete a revised PRSP due to transitional character. - Authorities encouraged to advance background technical work for PRSP in coordination with civil society and the international community and deepen pro-poor orientation of public expenditure. ### Risks, stress tests, and vulnerabilities - Identified vulnerabilities: - Financial system remains highly dollarized and subject to rapid shifts in market sentiment. - Investment environment weakened by uncertainties from the hydrocarbons law, which could harm growth prospects if not resolved. - Fiscal position sensitive to revenue/expenditure-sharing arrangements between central government and regions/municipalities. - Debt sustainability and stress tests (Figure 5 references): - NPV of Nonfinancial Public Sector Debt presented as percent of GDP under Fifth Review Baseline and Sixth Review Baseline. - Stress tests under the Sixth Review Baseline consider scenarios including: - Lower oil prices. - Higher nonconcessional financing. - Higher interest rates. - One time 30 percent devaluation. - Unchanged primary balance. - Potential shocks affecting hydrocarbons and fiscal revenues (footnote scenarios): - Decline could be due to: (i) a price drop of US$15 per barrel below the baseline in 2006, and US$10 below the baseline thereafter; (ii) a 30 percent drop in the average annual volume of natural gas output (by nine-thousand cubic meters per day) in 2006-2015, as might occur in the absence of improvements in the investment climate; or (iii) a linear combination of these shocks. - Adjustments to the hydrocarbons regime may be required to ensure continued natural gas output and exports. ### Staff appraisal summary and recommendations - General appraisal: - Political developments unfolded within the constitutional framework; tensions diffused; economic stability maintained. - Continued orderly resolution of political issues is key for a positive economic outlook given upcoming general elections and mid-2006 constituent assembly and referendum on regional autonomy. - Commendations: - Authorities commended for financial management during political transition and adherence to quantitative targets met with substantial margins. - Key staff recommendations: - Sustain the better-than-programmed fiscal position and continue firm control of the deficit. - Correct distortions in the hydrocarbons law promptly, including possible interim arrangements with companies. - Pursue approval of the budget framework law and finalize a revenue-neutral tax reform anchored on efficiency and equity, with personal income tax exemptions for low-income households. - Implement more timely petroleum product price adjustments and target subsidies to the most vulnerable. - Continue strengthening the debt structure to reduce vulnerability. - Maintain vigilance over the financial system and complete reforms (deposit insurance law, corporate restructuring and bankruptcy reform). - Consider gradual move toward greater exchange rate flexibility. - Advance PRSP technical work and deepen pro-poor public expenditure. *Source: Letter of Intent and Memorandum on Economic and Financial Policies (LOI and MEFP) as summarized in the staff report section provided.* ### 31. The staff believes that the program constitutes a critical counterweight to the ### _cr05393 - 31. The staff believes that the program constitutes a critical counterweight to the ### Program assessment and staff recommendations - The staff believes that the program constitutes a critical counterweight to the economy’s vulnerabilities. - Program objectives: - Ensure macroeconomic stability. - Support a continuation of structural reforms during the political transition. - Provide continuity and a framework for sound policy action by the successor government. - Staff actions supported: - Completion of the sixth review. - Waivers of nonobservance and applicability, and modification of performance criteria. - Rephasing and reduction of access under the Stand-By Arrangement, and treatment from now on as precautionary, in view of the reduced balance of payments need and proposed changes to the structural component of the program. ### Key macroeconomic outcomes and projections (selected) - Real GDP growth (annual percentage change): - 2001: 1.7 - 2002: 2.4 - 2003: 2.8 - 2004: 3.6 - Prel. 2005: 4.5 - Prog. 2005: 3.9 - Proj. 2006: 4.1 - CPI inflation (period average): - 2001: 1.6 - 2002: 0.9 - 2003: 3.3 - 2004: 4.4 - Prel. 2005: 4.7 - Prog. 2005: 5.3 - Proj. 2006: 3.4 - GDP deflator (annual percentage change): - 2001: 0.7 - 2002: 2.7 - 2003: 5.1 - 2004: 11.1 - Prel. 2005: 4.0 - Prog. 2005: 8.5 - Proj. 2006: 4.1 ### Fiscal sector: levels, balances, and composition (selected, percent of GDP and monetary amounts) - Combined public sector revenues and grants (percent of GDP): - 2001: 25.1 - 2002: 24.4 - 2003: 24.1 - 2004: 26.8 - Prel. 2005: 28.1 - Prog. 2005: 29.0 - Proj. 2006: 29.6 - Royalties on hydrocarbons (percent of GDP): - 2001: 2.6 - 2002: 2.3 - 2003: 2.8 - 2004: 3.4 - Prel. 2005: 3.7 - Prog. 2005: 5.4 - Proj. 2006: 6.7 - Expenditure (percent of GDP): - 2001: 32.0 - 2002: 33.2 - 2003: 32.0 - 2004: 32.3 - Prel. 2005: 33.2 - Prog. 2005: 32.5 - Proj. 2006: 32.7 - Pension-related spending (percent of GDP): - 2001: 4.7 - 2002: 4.9 - 2003: 4.7 - 2004: 4.3 - Prel. 2005: 4.9 - Prog. 2005: 4.1 - Proj. 2006: 3.9 - Interest payments (percent of GDP): - 2001: 2.6 - 2002: 2.6 - 2003: 2.8 - 2004: 2.9 - Prel. 2005: 3.0 - Prog. 2005: 2.9 - Proj. 2006: 2.6 - Overall balance (percent of GDP): - 2001: -6.8 - 2002: -8.8 - 2003: -7.9 - 2004: -5.5 - Prel. 2005: -5.2 - Prog. 2005: -3.5 - Proj. 2006: -3.0 - Non-hydrocarbons balance (percent of GDP): - 2001: -9.4 - 2002: -11.1 - 2003: -10.7 - 2004: -8.9 - Prel. 2005: -9.1 - Prog. 2005: -8.8 - Proj. 2006: -9.7 - Total nominal public debt (percent of GDP): - 2001: 60.1 - 2002: 69.2 - 2003: 73.8 - 2004: 76.4 - Prel. 2005: 74.6 - Prog. 2005: 72.1 - Proj. 2006: 71.1 - Total debt in NPV terms (percent of GDP): - 2001: 43.8 - 2002: 44.8 - 2003: 53.0 - 2004: 54.6 - Prel. 2005: 57.6 - Prog. 2005: 53.7 - Proj. 2006: 53.8 - Table 2 (operations of the combined public sector, in millions of bolivianos): - Revenue and grants (2005 Prel.): 13,520 - Current revenue (2005 Prel.): 12,142 - Total spending (2005 Prel.): 17,189 - Overall balance (deficit) (2005 Prel.): -3,668 - Financing (2005 Prel.): 3,668 - Public Debt (2005 Prel., millions of bolivianos): 32,346 - Nominal GDP (in millions of Bs.) (2005 Prel.): 53,790 ### Medium-term macroeconomic framework (selected projections, 2004-10) - Real GDP growth (annual percentage changes): - 2004: 3.6 - Prel. 2005: 4.5 - Prog. 2005: 3.9 - Proj. 2006: 4.1 - 2007: 3.9 - 2008: 3.0 - 2009: 3.0 - 2010: 3.0 - Total Revenue (percent of GDP): - 2004: 26.8 - Prel. 2005: 28.1 - Prog. 2005: 29.0 - Proj. 2006: 29.6 - 2007: 29.2 - 2008: 28.8 - 2009: 28.3 - 2010: 28.0 - Primary Expenditure (percent of GDP): - 2004: 29.4 - Prel. 2005: 30.2 - Prog. 2005: 29.6 - Proj. 2006: 30.1 - 2007: 29.6 - 2008: 28.7 - 2009: 28.1 - 2010: 27.6 - Primary deficit (percent of GDP): - 2004: -2.6 - Prel. 2005: -2.1 - Prog. 2005: -0.5 - Proj. 2006: -0.5 - 2007: 0.0 - 2008: 0.2 - 2009: 0.2 - 2010: 0.4 - NFPS debt (nominal, percent of GDP): - 2004: 76.4 - Prel. 2005: 74.6 - Prog. 2005: 72.1 - Proj. 2006: 71.1 - 2007: 69.4 - 2008: 68.0 - 2009: 66.5 - 2010: 64.8 ### External sector (selected) - Current account balance (percent of GDP): - 2001: -3.4 - 2002: -4.1 - 2003: 0.6 - 2004: 3.2 - Prel. 2005: 2.1 - Prog. 2005: 1.7 - Proj. 2006: 1.5 - Merchandise exports (percent of GDP): - 2001: 15.8 - 2002: 16.4 - 2003: 19.4 - 2004: 24.4 - Prel. 2005: 26.5 - Prog. 2005: 25.7 - Proj. 2006: 26.0 - Merchandise imports (percent of GDP): - 2001: 20.9 - 2002: 22.3 - 2003: 19.9 - 2004: 21.0 - Prel. 2005: 23.8 - Prog. 2005: 23.4 - Proj. 2006: 24.3 - Gross international reserves (end-of-period, US$ millions): - 2001: 1,375 - 2002: 1,073 - 2003: 1,268 - 2004: 1,424 - Prel. 2005: 1,426 - Prog. 2005: 1,614 - Proj. 2006: 1,636 ### Monetary and financial sector (selected) - Broad money (percent change, beginning of period): - 2001: -2.0 - 2002: -10.1 - 2003: -1.1 - 2004: -1.6 - Prel. 2005: 9.1 - Prog. 2005: 13.3 - Proj. 2006: 8.7 - Credit to private sector (percent change): - 2001: -15.2 - 2002: -9.3 - 2003: -4.9 - 2004: -6.8 - Prel. 2005: 7.7 - Prog. 2005: 3.8 - Proj. 2006: 3.6 - Dollarization indicators (end-period stocks): - Foreign currency deposits (percent of total deposits): - 2001: 92.2 - 2002: 91.9 - 2003: 90.6 - 2004: 86.5 - Prel. 2005: 84.0 - Prog. 2005: 83.4 - Foreign currency credit (percent of total loans): - 2001: 97.1 - 2002: 97.5 - 2003: 97.8 - 2004: 96.2 - Prel. 2005: 95.9 - Prog. 2005: 95.4 ### Public debt sustainability and stress tests (selected) - Table 10 baseline projections (NPV of non-financial public sector debt, percent of GDP): - 2004: 55 - 2005: 54 - 2006: 54 - 2007: 53 - 2008: 52 - 2009: 51 - 2010: 50 - 2015: 44 - Stress test scenarios include: - A1. Lower oil prices (US$15 below baseline in 2006 and US$10 below thereafter). - A2. Higher level of nonconcessional financing (increase in net nonconcessional financing by 1.2 percent on average in 2007-2015). - A3. Higher interest rates on nonconcessional borrowing (assumes a 300 basis points increase). - A4. One time 30 percent devaluation in 2005. - A5. Primary balance unchanged starting 2005. ### Fund financing and schedules (selected) - Schedule of purchases under the Stand-By Arrangement, 2005-06 (Table 8) summarized from Fund staff estimates (rows show Approved and Proposed tranches and dates as in the source). - Indicators of Fund credit (Table 9): - Outstanding Fund credit (in millions of SDRs): - 2001: 164.9 - 2002: 143.7 - 2003: 187.5 - 2004: 197.7 - 2005: 199.8 - 2006 (projection): 187.6 - Outstanding Fund credit (in percent of quota): - 2001: 96.1 - 2005: 116.5 - 2009 (projection): 19.8 ### Vulnerability indicators and financial sector health (selected) - Key indicators (latest observations/projections): - Real GDP growth (in percent): Proj. 3.9 - CPI inflation (period average, in percent): Proj. 5.3 - Short-term interest rate (percent): 8.5 (August) - Exchange rate NC/US$ (end of period): 8.0 (September) - External sector indicators (latest/proj.): - Gross international reserves (GIR) in US$ billion: Proj. 1.4 - GIR in percent of ST debt at remaining maturity (RM): Proj. 240 - Net international reserves (NIR) in US$ billion: Proj. 1.3 - Total gross external debt (percent of GDP): Proj. 63.4 - Total gross external debt (percent of exports of GNFS): Proj. 212 - Public sector indicators (latest/proj.): - Overall balance (percent of GDP): Proj. -3.5 - Primary balance (percent of GDP): Proj. -0.5 - Gross PS financing requirement (percent of GDP): Proj. 6.1 - Public sector gross debt (percent of GDP): Proj. 72.1 - Financial sector indicators (July observations): - Capital adequacy ratio (percent): 14.8 (July) - NPLs in percent of total loans: 14.3 (July) - Provisions in percent of NPLs: 73.7 (July) - Return on average assets (percent): 0.2 (July) - Return on equity (percent): 1.9 (July) - FX deposits held by residents (percent of total deposits): 85.2 (August) - FX loans to residents (percent of total loans): 94.5 (August) *Source: IMF staff estimates, projections, and tables as provided in the content unit.* ### 1. Since the completion last April of the fifth review of our program supported by the ### _cr05393 - 1. Since the completion last April of the fifth review of our program supported by the ### Political developments and program adherence - Since the completion last April of the fifth review of our program supported by the Stand-By Arrangement (SBA), Bolivia experienced: resignation of former President Mesa; changeover to the current government led by President Rodríguez; congressional approval of a constitutional amendment enabling general elections next December; and a political agreement on a constitutional assembly and a referendum on regional autonomy to be held in mid-2006. - These developments unfolded within the established political and institutional framework and economic stability has been maintained. - The government attaches paramount importance to the SBA-supported economic program and, as detailed in the attached Memorandum on Economic and Financial Policies (MEFP), has fully adhered to the agreed macroeconomic policies—having observed, with margins, all the end-June quantitative performance criteria and met, or expecting to have met, all end-September quantitative performance criteria. - The government requests waivers of applicability for two end-September performance criteria: the combined public sector deficit and domestic financing (no final information available as of the date of the letter). - The government requests a waiver for the nonobservance of the end-June performance criterion for approval of a revised 2005 budget law, because a revised law submitted as a prior action became inconsistent with the fiscal situation after approval, last May, of the new hydrocarbons law. - Due to the interim nature of the current government, some scaling down and rephasing of certain structural reforms will occur; specifically, the government will refrain from submitting to Congress a comprehensive tax reform (an end-September structural benchmark), although a draft tax reform proposal will be prepared for the next government. ### Requests to the Fund and arrangement adjustments - Request completion of the sixth review under the SBA, contingent on observance of the quantitative performance criteria for end-September specified in Table 1 of the MEFP, with waivers of applicability for the fiscal deficit and domestic financing of the combined public sector. - Proposal to reduce total access under the SBA by SDR 25.72 million (15 percent of quota), corresponding to the last purchase, as currently scheduled. - Proposal that the remaining amount of SDR 17.14 million (10 percent of quota) available under the SBA after the sixth-review purchase be rephased and linked to the next and final review, completion contingent on observance of the performance criteria for end-December 2005 specified in Tables 1 and 2 of the MEFP. - Intention to treat the arrangement as precautionary. - Final review discussions would allow the next government to outline medium-term economic policies and poverty reduction strategy, including intentions regarding relations with the Fund and potential implications for Bolivia of the G-8 debt cancellation initiative. ### Macroeconomic performance in 2005 (developments under the 2005 program) - Economic growth remained strong during the first half of the year, buoyed by the hydrocarbons sector. - Temporary supply disruptions associated with road blockades led to an increase in inflation in May-June, partially reversed thereafter. - The trade surplus in the first semester of 2005 was broadly in line with program projections. - All end-June quantitative performance criteria were observed (Table 1). - The combined public sector recorded an overall surplus of 0.4 percent of GDP during the first seven months, reflecting higher hydrocarbon revenues and lower spending. - Large increase in revenue related to strong gas exports and the changed hydrocarbons regime, including the introduction of a new tax—the Impuesto Directo a los Hidrocarburos (IDH). - Spending constrained, reflecting slower-than-projected execution of capital projects and delays in loan disbursements due to political events. - Central bank actions: raised repo rates by over 100 basis points in response to deposit withdrawals; liquidity assistance to banks fully repaid as deposits recovered. - Net liquid foreign assets of the financial system increased significantly; central bank reserves much higher than programmed. - Significant sales of foreign currency to the central bank matched the monetary impact; central bank placed increasing amounts of local currency paper with declining interest rates to forestall inflationary pressures. - Exchange rate: bilateral rate virtually unchanged against the U.S. dollar, implying a highly competitive real effective exchange rate; marginal appreciation of the Boliviano in mid-July under the crawling peg; widened buy-sell spread; small additional appreciation in mid-September. - Debt management: increased the share of local currency treasury paper by over 20 percentage points since end-2004; met placement targets despite bunching of maturing treasury bills and tripled the average maturity of newly issued treasury paper to over three years; introduced a new electronic auction system. - Balance of payments: substantially stronger than programmed; current account surplus broadly in line with program; capital and financial account recorded a higher-than-projected surplus; resulted in a higher-than-programmed level of international reserves. ### Updated 2005 macroeconomic policy framework and projections - Real GDP growth: expected to increase from 3.6 percent in 2004 to about 4 percent in 2005, underpinned by hydrocarbons output. - Twelve-month inflation projected at 4.2 percent, compared with the June peak of 6.4 percent; program inflation target was 3.8 percent. - Fiscal result: new hydrocarbons taxation regime to bring higher fiscal revenues in 2005—savings to contribute to a lower-than-programmed fiscal deficit. - Financial system: deposits and NIR expected to maintain gains recorded thus far. - Monetary target: take action to reduce the 12-month growth in currency issue from the high of over 30 percent in June to 26 percent by December 2005. - Net international reserves (NIR): projecting a US$230 million increase in NIR during 2005, compared with the programmed increase of US$40 million. - Proposal to raise the end-December program floor on the increase in NIR partially—to US$135 million (the mid-point between the original target and the current projection). - Financial system liquid foreign asset coverage of deposits projected to be around 54 percent. ### Fiscal policy specifics for 2005 and proposed end-December adjustments - Fiscal deficit trend: from nearly 9 percent of GDP in 2002 to 3.5 percent of GDP in 2005 (expected). - Fiscal deficit in 2005 expected to amount to at most Bs 2,728 million (3.5 percent of GDP, i.e., 2 percent of GDP lower-than-programmed before grants), compared with the original program target of Bs 3,763 million (4.8 percent of GDP). - These ratios are based on a revised GDP; in relation to the programmed GDP, the corresponding ratios are 3.7 and 5.2 percent, respectively. - Government has sent a revised budget to Congress to increase implementation of infrastructure and social projects, using a share of new hydrocarbons tax revenue and promoting recovery in external project loan disbursements, with attention to pro-poor initiatives. - Current spending will increase due to higher fuel subsidies and transfers to a low-income housing program. - Proposal for a corresponding downward adjustment to the end-December 2005 ceiling on the deficit of the combined public sector (Table 1). ### Preliminary macroeconomic framework for 2006 - Real GDP growth envisaged in the range of 4–4½ percent for 2006. - Expectation of lower inflation and a further reduction of financial sector vulnerabilities. - Growth predicated on acceleration in mining and construction sectors, reflecting large ongoing mining investments and higher capacity utilization in hydrocarbons. - Prudent management of the revenue windfall from hydrocarbons: some savings to reduce the fiscal deficit and avoid creating expenditure rigidities for the medium term. - Proposed fiscal stance and competitive exchange rate, together with strong hydrocarbons and metals prices, expected to help maintain external current account and overall balance of payments surpluses and increase reserve coverage of financial sector deposits. - 2006 budget submission (intended prior to the Executive Board meeting) will raise infrastructure and social capital spending while providing for a further reduction in the fiscal deficit. - Tax revenue: increase in public sector revenue by 0.3 percent of GDP, including 1 percent of GDP in hydrocarbon revenues; revenue projection includes elimination of the financial transactions tax (FTT) on local currency sight deposits; the FTT on foreign currency sight and savings deposits will be maintained at the current rate to promote de-dollarization. - Expenditure: budget proposal incorporates a 1½ percent of GDP increase in public investment relative to projected 2005; continue to contain current spending in relation to GDP, including the wage bill; expect further reduction in pension costs. - Deficit: the limit on the deficit of the combined public sector authorized in the government’s proposal will be equivalent to 3.7 percent of GDP; based on the Fund staff’s revenue projection and assuming an implementation rate of 93 percent of the investment budget, this is consistent with a projected fiscal deficit of 3 percent of GDP. - Expectation that the 2006 budget will be approved by Congress or on a lapse-of-time basis by end-December 2005; request to convert such approval into a structural benchmark (currently an end-December PC). ### Structural policies and implementation status - Fiscal area: Congress elevated to law the new tax code procedures. - Financial sector: provisioning and reserve requirements tightened; Congress approved a law setting up the Financial Restructuring Fund (FRF) and enhancing the autonomy of the banking superintendency and the central bank. - Hydrocarbons policy: Congress enacted a new law in May; current administration has moved to implement and regulate as mandated, including tax-related provisions. - Given far-reaching changes in the hydrocarbons law, altered energy price outlook, and ongoing contacts with oil companies on implementing regulations, the impact of the new law still needs full assessment; no further legislative adjustments contemplated at this stage and any potential review of hydrocarbons policy would need to be conducted by the next government. *Source: Memorandum on Economic and Financial Policies and accompanying letter (October 7, 2005).* ### 15. Looking ahead, we intend to make significant additional progress within our ### _cr05393 - 15. Looking ahead, we intend to make significant additional progress within our ### Fiscal reforms - Budget framework - Prior to the Executive Board meeting, submit to Congress a draft Budget Framework Law aimed at enhancing the budget process at all levels of government. - Enhancements are technical in nature and consistent with any degree of fiscal decentralization or regional autonomy. - Expenditure and debt management - Complete, by end-December 2005, 50 percent of the registry on health and education sector employment (benchmark). - Implement a registry system on subnational debt for nine regional governments (prefecturas) and 17 municipalities (benchmark). - These actions are in the context of a broader program to register all public sector employees and pensioners. - Tax reform - Submission/approval of a broad tax reform package (originally with end-September/end-October benchmarks) is not advisable under the current administration; full ownership by the next government is required. - Prepare a draft tax reform bill for consideration by the new government, taking into account FAD technical assistance recommendations. - The draft will include, inter alia, the introduction of a personal income tax that would exempt about 80 percent of the population, and will be at least revenue neutral and anchored on the objectives of equity and efficiency. - Plan to finalize the draft proposal by end-December 2005 (benchmark). ### Financial sector reforms - Deposit insurance - Prior to the Executive Board meeting, submit to Congress a draft law introducing a partial coverage deposit insurance scheme with adequate contributions by financial institutions. - Objective: strengthen depositor protection in the context of bank liquidation and resolution procedures. - Corporate restructuring and bankruptcy - By end-December 2005, submit to Congress draft legislation to improve the corporate restructuring and bankruptcy framework (benchmark). - Rationale: lack of an appropriate framework compounds vulnerabilities in Bolivia’s financial system. - Privatization - By end-year, sell the remainder of the state’s assets in banks where the public sector holds a majority ownership (performance criterion). ### V. MEDIUM-TERM OUTLOOK - Revenue and fiscal trajectory - The combination of higher hydrocarbons taxation, stronger international commodity prices, and the tax reform to be proposed would boost fiscal revenue over the medium-term. - Enlarged revenue envelope will allow further reduction in the fiscal deficit and a more rapid reduction in the debt ratio than previously projected, without undermining poverty-reduction and growth-enhancing efforts. - Institutional and international support - Coordinate with the international community to consolidate the conclusions of the National Dialogue completed in December 2004, which the authorities intend to publish, to facilitate formulation of a poverty-reduction strategy by the next government. - Implementation of the G-8 debt relief initiative is expected to further enhance Bolivia’s medium-term economic outlook. ### Quantitative performance criteria, adjusters, and structural conditionality (highlights from Tables) - Quantitative performance criteria (Table 1) include limits and targets with exact cumulative-flow reporting conventions: - Deficit of the combined public sector (cumulative flows from December 31, 2004, in millions of US dollars and bolivianos). - Net domestic financing of the combined public sector. - Central Bank net credit to the NPFS. - Net domestic assets of the central bank. - Net international reserves of the central bank. - Net nonconcessional external debt and external debt with maturities up to one year. - Adjusters and specific program rules (selected) - Limits on the deficit of the combined public sector will be adjusted downward by the difference between actual and projected program grants and by shortfalls in HIPC debt relief (as specified). - Limits on net domestic financing of the NFPS will be adjusted upward by the difference between projected and actual net external financing to the NFPS (excluding HIPC debt relief) up to the designated ceiling and adjusted downward by overdue obligations to foreign official creditors. - Limits on the NDA of the BCB will be adjusted downward by overdue obligations to foreign official creditors and adjusted for flows of Central Bank financial system foreign currency deposits. - Ceiling on NIR will be adjusted upwards by overdue obligations to foreign official creditors and adjusted downward by shortfalls relative to projected currency issue, up to the designated ceiling; adjusted for flows of Central Bank financial system foreign currency deposits. - The limit on net nonconcessional external debt is reduced by shortfalls between actual and projected disbursements of loans for financial and corporate restructuring. - Structural conditionality for the Sixth and Seventh Reviews (Table 2) — selected entries and statuses - Hydrocarbons Law and regulations: June 30, 2005 — Not observed. No further legislative adjustments contemplated at this stage. - Passage of a revised budget law for 2005 with spending levels consistent with staff’s revenue projections and the program deficit target after grants of the combined public sector of 5.2 percent of GDP: June 30, 2005 — Breached. Grant waiver. - Approval by Congress of the law regulating procedural requirements before the Tax Superintendency: June 30, 2005 — Observed. - Submission to Congress of an Organic Budget Law guided by principles of budget unity, transparency, comprehensiveness, and appropriations determined by Congress: June 30, 2005 — Not observed. Modified and converted into prior action for sixth review; proposed prior action for sixth review is submission to Congress of a Budget Framework Law. - Submission to Congress of a comprehensive tax reform including introduction of a personal income tax exempting 80 percent of the population: September 30, 2005 — Modify benchmark; approval by October 31, 2005 — Modify benchmark. Proposed modified benchmark: preparation of draft bill for consideration by the next government by December 31, 2005. - Registry on health and education employment and audit on subnational debt: September 30, 2005 — Progress made; rescheduled to December 31, 2005. Proposed modified benchmark: Complete 50 percent of the registry and implement registry system on subnational debt for nine prefecturas and 17 municipalities by December 31, 2005. - Submission of a draft law creating a deposit insurance scheme: September 30, 2005 — Convert into prior action for sixth review. - Submission of draft legislation to improve corporate restructuring and bankruptcy framework: September 30, 2005 — Reschedule to December 31, 2005. - Sale and transfer on final basis of the ownership of the state’s participation in banks majority-owned by Nafibo: December 31, 2005 — Maintain performance criterion. _Source: BOLIVIA—TECHNICAL MEMORANDUM OF UNDERSTANDING, September 16, 2005 (extracts from _cr05393)._ ### 2. Quantitative performance criteria are set with respect to: (a) the deficit of the ### _cr05393 - 2. Quantitative performance criteria are set with respect to: (a) the deficit of the ### Quantitative performance criteria — scope and definitions - Criteria are set with respect to: - (a) the deficit of the combined public sector (CPS); - (b) net domestic financing of the CPS; - (c) Central Bank of Bolivia (BCB) net credit to the nonfinancial public sector (NFPS); - (d) net nonconcessional external debt of the public sector; - (e) external debt of the public sector with maturities up to one year; - (f) the change in the net international reserves (NIR) of the BCB; and - (g) the change in the net domestic assets (NDA) of the BCB. - Deficit of the CPS: - Defined as the sum of the net external financing of the NFPS and the net domestic financing of the CPS. - CPS includes operations of the NFPS and proceeds from the operating balance of the BCB. - NFPS composition: - (i) the general government (central administration, public sector social security, prefectures, municipalities, and other decentralized agencies); - (ii) the nonfinancial public enterprises. - Net external financing of the NFPS comprises: - (i) external disbursements to the NFPS; - (ii) total HIPC debt relief from refinancing operations; - (iii) net disbursements of funds for the NFPS administered by the BCB as trust funds; - (iv) unpaid current interest obligations; - less (v) amortization due by the NFPS after HIPC debt relief for the amortization component of the stock of debt reduction operations; - (vi) net payments in settlement of the external arrears of the NFPS; - (vii) shareholder contributions to the Corporación Andina de Fomento (CAF). - HIPC debt relief definition: - Includes relief under the original and enhanced initiatives from reduction in amortization arising from stock of debt reduction operations and rescheduling, and beyond HIPC relief (debt relief granted by HIPC creditors beyond that agreed within the enhanced HIPC framework). - Net domestic financing of the CPS comprises the sum of: - (i) the increase in the net claims of the domestic financial system on the NFPS (excluding deposits in the BCB related to foreign loans administered as trust funds); - (ii) the cash operating results of the BCB (before distribution to the treasury’s account, with negative sign); - (iii) the change in the NFPS liabilities to the private sector in the form of fiscal certificates; - (iv) the increase in the domestic floating debt of the NFPS; - (v) all domestic borrowing by the NFPS, including net disbursements to the NFPS related to any new domestic debt instruments issued by the government and held outside the NFPS. - Exclusion: Valuation changes (due to changes in inflation) in the stock of domestic debt denominated in inflation-indexed units (UFVs) are excluded from the computation of net domestic financing of the CPS. - BCB cash operating result components: - Receipts: (i) interest on deposits abroad; (ii) earnings on the BCB portfolio with the NFPS and the financial system; (iii) interest payments by the treasury on government paper held by the BCB; (iv) interest on LAIA accounts; (v) commissions and realized foreign exchange gains; (vi) other current receipts, excluding any sale of fixed assets, including gold. - Payments: (i) current payments to the IMF, excluding repurchases and SAF, ESAF and PRGF loan repayments; (ii) other international organizations, excluding amortization and interest on loans administered by the BCB as trust funds for the NFPS; (iii) the domestic financial institutions on account of reserve requirements; (iv) interest on certificates of deposit and treasury bills B and D; (v) administrative and other current expenditures. - Transfers to the treasury out of operating profits are excluded from expenditure when consolidating BCB cash operating result with NFPS accounts. - Domestic floating debt of the NFPS: - Liabilities incurred for goods and services received but not yet paid for, excluding claims on and liabilities to other entities within the NFPS. - Floating debt for public sector wages at month end includes: (i) unpaid wage increases; (ii) wages for work performed in a previous month but not yet paid. - Includes floating debt of departmental capitals, El Alto, and municipalities having subscribed an adjustment program (PRF) with the government as of December 31, 2002. - BCB net credit to the NFPS: - Defined as BCB’s gross credit to the Treasury (including emergency and liquidity assistance, and any holdings of treasury bills and bonds by the BCB) minus deposits of all NFPS entities with the BCB. - Excludes net disbursements of foreign loans administered by the BCB as trust funds for the NFPS. - Net nonconcessional external debt of the public sector: - Outstanding external debt of the public sector, excluding: - (i) concessional loans with a grant element of at least 35 percent using the OECD commercial interest reference rates as of August 15, 2005; - (ii) changes in BCB liabilities included in the definition of NIR; - (iii) debt reprogrammed with official creditors; - (iv) the use of Fund resources; - (v) the effect of any stock-of-debt operations under the enhanced HIPC Initiative or beyond-HIPC relief. - Public sector includes: (i) the NFPS; (ii) the Central Bank of Bolivia (BCB) and other financial public sector entities, including NAFIBO and FONDESIF. - External debt valuation: at end–2004 U.S. dollar exchange rates of 0.73351 Euro = US$1, 104.12 Japanese yen = US$1, and other currencies according to end–2004 exchange rates published in IMF’s International Financial Statistics. - External debt with maturities up to one year: - Excludes: (i) normal import credits; (ii) reserve liabilities of the central bank; (iii) the use of Fund resources. - Net International Reserves (NIR) of the BCB defined as: - (i) BCB liquid foreign assets; less: - (ii) BCB liabilities to nonresidents (including swaps and the net position under the Latin American Integration Association, LAIA, clearing mechanism) with an original maturity of at most one year; - (iii) outstanding purchases and disbursements from the Fund (excluding disbursements from the trust fund); - (iv) BCB net liabilities to the Latin American Reserve Fund (FLAR), including bridging loans (even those obtained by the NFPS) and those obtained by pledging gold. - Change in NIR measured by differences in stocks. - NIR exclusions: (i) gains from conversion of monetary gold into foreign exchange; (ii) gains from acquisition of domestically produced gold; (iii) financial institutions’ liquid asset requirement holdings (RAL), whether or not included in the BCB balance sheet. - Conversion rules: BCB assets and liabilities in foreign currencies other than US$ converted at market exchange rates at date of NIR measurement, except: (i) gold valued at US$375 per troy ounce; (ii) SDR holdings and net Fund position converted at US$1.55301 = SDR1. - NIR will be valued at the accounting exchange rate of Bs 8.15 = US$1 in 2005. - NDA of the BCB: - Defined as currency issue less the NIR of the BCB. ### Adjusters (impact on limits and floors) - 3. Limits on the deficit of the CPS will be adjusted downward by the difference between actual and projected program grants (i.e., grants not earmarked for projects or “transferencias de libre disponibilidad”) if actual grants exceed projected program grants. The adjustment limited to shortfall in actual concessional program loans from projected concessional program loans. - 4. Limits on the deficit of the CPS shall be reduced (increased) by the shortfall (excess) between actual and projected HIPC debt relief. - 5. Limits on the deficit of the CPS for June 30 and September 30, 2005 will be reduced by 33 percent of any excess of actual tax revenue over the programmed levels specified in Table 1 of the MEFP. - 6. Limits on net domestic financing of the CPS will be adjusted upward by the shortfall in cumulative net external financing to the NFPS, excluding medium- and long-term liabilities transferred from the BCB to the treasury and from other financial public sector institutions, and excluding HIPC debt relief, up to the designated ceiling. - 7. Limits on net domestic financing of the CPS will be adjusted downward by: - (1) any medium- and long-term liabilities transferred from the BCB to the treasury; - (2) any liabilities transferred from other financial public sector institutions to the treasury. - 8. Limits on net domestic financing of the CPS and on the change in the NDA of the BCB will be adjusted downward, and the target for NIR of the BCB adjusted upward, by the amount of any overdue obligations to foreign official creditors. - Foreign official creditors include, but are not limited to: (i) multilateral organizations; (ii) bilateral official creditors excluding debts covered under Paris Club or other bilateral rescheduling or debts under negotiation including service on rescheduling but excluding old debts to countries in the region; (iii) supplier’s creditors without official guarantee excluding already rescheduled debt service; (iv) holders of private bonds excluding zero-coupon bonds used in debt conversion schemes. - 9. Limits on central bank net credit to the NFPS will be adjusted downward by any transfer of cash from the BCB to the treasury associated with transfer of any medium- and long-term liabilities. - 10. Limits on net nonconcessional external debt will be reduced by the amount of the shortfall between actual and projected external financing for financial and corporate restructuring, up to the ceiling in Table 1 of the MEFP. - Loans for financial and corporate restructuring include CAF credits of US$10 million for 2005 and guided by specified principles (market-based fund structure, eligibility of viable companies, safeguards from political influence, government safeguards from claims if company fails, coordination with voluntary workout law, non-subsidy provision over long run, management by international managers). - 11. Floors on change in NIR of the BCB will be adjusted downward for shortfalls relative to projected currency issue, up to designated ceiling in Table 1 of the MEFP. - 12. Floors on change in NIR of the BCB will be adjusted upward/downward by net increase/decrease in legally required and excess reserves denominated in foreign currency by financial institutions held with the BCB. Conversely, limits on change in NDA of the BCB will be adjusted downward/upward by net increase/decrease of such reserves. ### Selected reporting requirements - 13. Monthly updates for fiscal and monetary information: provided at most 25 calendar days after the end of each month. Quantitative targets and limits measured as cumulative flows from December 31, 2004. - 14. Treasury to remit to the BCB, on a weekly basis, information on all placements of treasury bonds other than open market operations (necessary to monitor deficit and net domestic financing of the CPS). - 15. Floating debt of departmental capitals, El Alto, and municipalities with PRF as of December 31, 2002 to be reported semiannually, with at most a 90–day lag; included in floating debt figures as soon as available. - 16. Quarterly estimate of pro-poor spending and pro-poor spending excluding wages of the NFPS to be provided at most 90 calendar days after the end of each quarter (reporting agency: Fiscal Programming Unit of the Ministry of Finance (UPF)). - Pro-poor spending of the SPNF includes current and capital spending on health (excluding payments to “beneméritos”) and education (excluding universities); capital spending on basic sanitation, urban development and rural development (including spending on PLANE). Excludes pension outlays. ### Statement and press release highlights (October 31, 2005) - IMF Executive Board completed the sixth review under an SDR 171.5 million (about US$248.9 million) Stand-By Arrangement originally approved for SDR 85.75 million (about US$124.5 million) on April 2, 2003, augmented and extended through March 31, 2006. - Board granted request to reduce the size of the current arrangement by SDR 25.72 million (about US$37.3 million) to SDR 145.78 million (about US$211.6 million). - Completion of the review makes an amount equivalent to SDR 17.14 million (about US$24.9 million) available immediately. Remaining SDR 17.14 million could be made available subject to Board approval during the next and final review. - Board granted waivers for: applicability of performance criteria on combined public sector deficit and domestic financing outturns relative to end-September quantitative performance criteria; non-observance of end-June 2005 performance criterion on passage of a revised 2005 budget law. - Prior actions submitted as part of sixth review (laws submitted to Congress): - (i) budget proposal for 2006; - (ii) budget framework law; - (iii) law establishing a deposit insurance scheme. - All prior actions were in line with MEFP and do not affect staff appraisal thrust. - Budget proposal for 2006: - Overall deficit amounting to Bs 3.1 billion (3.7 percent of projected GDP). - After adjustments in the MEFP—using staff’s higher revenue projections and applying agreed 93 percent implementation rate of the capital budget—the projected fiscal deficit amounts to Bs 2.6 billion (3.0 percent of GDP). - Budget submitted to Congress before 30th meeting of current Congressional session which started on August 4; constitutional provision applies that budget will be approved on lapse of time basis if Congress does not vote within 60 calendar days. - Budget Framework Law: - Aimed at improving budget process at all government levels; establishing medium-term macro-fiscal framework; strengthening role in setting priorities and applying hard budget constraints; enhancing transparency and minimum reporting requirements, including economic and functional classifications based on international standards. - Deposit Insurance Law: - Would create a deposit insurance fund; determine sources of financing; specify deposit insurance conditions if a bank is forcibly liquidated or resolved. - Protect depositors up to a limit of US$15,000 in event of forced liquidation. - Specifies bank contributions by risk classification and currency composition of deposits. - Would derogate Article 38e of the Central Bank Law (implicit “blanket guarantee”) and modify Article 38d to introduce strengthened procedures for authorities to declare a state of systemic risk, enabling adoption of emergency measures. - Ms. Anne O. Krueger (First Deputy Managing Director and Acting Chair) assessment and policy priorities: - Macroeconomic stability in Bolivia maintained in 2005 despite political developments; economic activity picked up after social tensions; inflation in single digits; external current account in surplus; financial system deposits recovered; central bank reserves strengthened. - Authorities committed to maintaining fiscal deficit on declining trend by saving part of large increase in hydrocarbons revenue resulting from an increase in the tax rate and strong gas export prices. - Central bank implementing measured and appropriate monetary policy; international reserves being rebuilt amidst decline in policy interest rates and improvement in maturity structure and currency composition of domestic debt. - Policy priorities moving forward: - Prudent management of hydrocarbons-based revenue; - Removal of impediments to investment in hydrocarbons sector; - Achieve balance between revenue allocations and spending responsibilities at all government levels; - Progress with tax reform; - Implement more market-based petroleum product pricing mechanism; - Appropriately focus poverty-reducing spending; - Further reduce vulnerabilities in the financial sector. *Source: IMF staff report and Press Release materials (October 31, 2005).* ### 1. On behalf of the Bolivian authorities, we thank Management for their engagement ### _cr05393 - 1. On behalf of the Bolivian authorities, we thank Management for their engagement ### Political Developments - President Mesa resigned amid social unrest; both presidents of the Senate and the Lower Chamber declined to take over. - President of the Supreme Court Eduardo Rodríguez was sworn in as President on June 9. - Congress amended the constitution to allow general elections on December 4. - A political settlement was reached to hold a constitutional assembly and a referendum on regional autonomy in mid-2006. - Presidential succession and other political arrangements were carried out within the legal framework. ### Economic Performance under the SBA - The Stand-By Arrangement (SBA) is regarded by the authorities as critical to preserve macroeconomic stability during the political transition. - All end-June quantitative performance criteria were observed. - Fiscal deficit was smaller than programmed. - Target for accumulation of net international reserves was met with a large margin. - Preliminary information indicates all end-September quantitative performance criteria were also met. - Structural reforms advanced: - Congress passed new tax code procedures. - Law enhancing the Financial Restructuring Fund and enhancing the autonomy of the banking superintendency and the central bank. - Tightened provisioning and reserve requirements. - Authorities submitted three draft bills to Congress: 2006 budget law (consistent with a reduction in the programmed fiscal deficit to 3 percent of GDP), Budget Framework Law, and a law introducing a partial-coverage deposit insurance scheme with contributions from financial institutions. ### Economic Performance in 2005 - Real growth in 2005 is forecast at 4 percent (higher than 2004 at 3.6 percent), driven by a significant increase in hydrocarbons output; lower than envisaged under the program. - Twelve-month inflation expected to decrease to 4.2 percent, from a peak of 6.4 percent in June. - Program inflation target was 3.8 percent; the overrun is mainly associated with temporary supply disruptions (road blockades) and Boliviano depreciation versus regional currencies. - Balance of payments in the first semester substantially stronger than programmed. ### Fiscal Policy - Public sector recorded an overall surplus of 0.4 percent of GDP during the first seven months of the year (reflecting higher revenues and lower spending). - Revenue increases due to improvements in tax administration, strong gas exports, and introduction of a new tax on hydrocarbons. - Spending containment attributed mainly to slow implementation of public investment. - Projected fiscal deficit for 2005 adjusted downward to 3.5 percent of GDP, 2 percentage points lower than the programmed deficit before grants. - Public investment implementation expected to recover later in the year, financed in part by a share of revenue from the new hydrocarbons tax and increased project-financing external disbursements. - Anticipated increases in current spending for fuel subsidies and transfers to a housing program targeted to low-income families. - Measures to improve control of wages, pensions, and sub-national debt: - Creating registers for public sector employees and pensioners; expected to cover 50 percent of the health and education sector employees by end-December 2005. - Register system for the debt of 9 regional governments and 17 municipalities presented to sub-national government. - Tax reform under the SBA: - Submission and approval not possible under the interim government; authorities will prepare a draft tax reform law by end-December for consideration by the new government. - Proposal will include, inter alia, a personal income tax and be anchored on equity and efficiency objectives. ### Monetary and Exchange Rate Policies - Policies consistent with low inflation and accumulation of foreign exchange reserves. - Deposit withdrawals during May and June pressured reserves; central bank temporarily raised interest rates on liquidity loans. - Deposits recovered; liquidity assistance to banks fully repaid. - Net liquid foreign assets of the financial system increased significantly; central bank reserves now much higher than programmed. - Increased demand for local currency; central bank increased placements of local currency paper to prevent inflationary pressures. - Local currency interest rates declined given increased preference for local currency. - Exchange rate regime and operations: - Crawling peg regime contributed to a highly competitive real effective exchange rate amid appreciation of regional currencies. - Monetary authorities marginally appreciated the Boliviano in mid-July and widened the bid-offer spread; a small additional appreciation was introduced in mid-September. - Domestic debt management improvements: - Share of local-currency Treasury paper in open market operations increased by over 20 percentage points since end-2004. - Average maturity of new issuances tripled to over three years. - New electronic auction system introduced to improve transparency and information-sharing. - International reserves and monetary targets: - Projected increase in net international reserves revised upwards to US$230 million in 2005, compared with US$40 million originally programmed. - Proposed target for end-December set at US$135 million, reflecting electoral-period withdrawal risks. - Authorities will reduce 12-month growth in currency issuance from 30 percent in June to 26 percent by December 2005 and will closely monitor foreign exchange market developments. - By end-December, draft legislation to expedite corporate restructuring and bankruptcy procedures will be submitted to Congress; plans to sell the remainder of the state's assets in a majority-state-owned bank by year-end. ### Prospects and Vulnerabilities - Authorities project real GDP growth in the range of 4-4½ percent in 2006, lower inflation, and a further reduction of financial sector vulnerabilities. - Growth supported by acceleration in mining and construction and higher capacity utilization in hydrocarbons. - Current administration implementing and regulating the new hydrocarbons law approved by Congress in May; implementation discussions with oil companies ongoing, so full impact not yet assessed. - No further legislative adjustments to hydrocarbons law contemplated at this stage; any review to be conducted by the next government. - Fiscal and external outlook: - Some hydrocarbon revenues will be saved to reduce the fiscal deficit and avoid creating medium-term expenditure rigidities. - Fiscal stance, competitive exchange rate, and high prices for hydrocarbons and metals expected to contribute to current account and overall balance of payments surpluses and further increases in international reserves. - Structural improvements and remaining vulnerabilities: - Fiscal deficit declined from almost 9 percent of GDP in 2002 to 3.5 percent in 2005, improving the economy’s position and reducing the debt ratio prospects. - Remaining vulnerabilities include high dollarization of the financial system and sensitivity to political crises; inadequate distribution of revenues and spending responsibilities between central and sub-national governments; rising fuel subsidies. - Policy challenges and constraints: - Need to design an adequate fiscal decentralization policy and modify revenue/spending distribution to ensure fiscal sustainability. - Flexible price-setting mechanism for fuel is needed but not politically feasible in current circumstances. - Final review consultations expected to give new authorities an opportunity to outline medium-term economic policies and future arrangements with the Fund. ### Request to the Executive Board - Given improved performance and progress, authorities request favorable consideration for: - (i) conclusion of the sixth review; - (ii) waivers of nonobservance and applicability, and modification of performance criteria; and - (iii) rephasing and reduction of access under the SBA, and precautionary treatment henceforth. *Source: IMF staff report as presented by the Bolivian authorities in document _cr05393.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05393.pdf_