Albania and the IMF

Press Release: IMF Completes First Review and Approves US$5 Million Tranche under PRGF for Albania

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Albania—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Tirana, January 7, 2003

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

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

Dear Mr. Köhler,

1. Since the start of Albania's current Poverty Reduction and Growth Facility (PRGF) arrangement, macroeconomic stability has been maintained, and all quantitative performance criteria have been observed. However, we regret delays in implementing structural reforms. In particular, parliamentary approval for the closure of duty-free shops at all land crossing border areas—an end-September 2002 structural performance criterion—was delayed temporarily. The impact of this short delay has been minor, given that in July 2002, we adopted measures to prevent the sale of alcohol and tobacco in these shops. On this basis, we request a waiver for the nonobservance of this structural performance criterion.

2. The attached supplementary Memorandum of Economic and Financial Policies (MEFP) and the Technical Memorandum of Understanding describe our economic program for the period ahead. In particular, the draft 2003 budget has been prepared and submitted to parliament, and is supported by a well-specified set of measures for improving tax collection. As prior actions for the completion of this review, we will secure parliamentary approvals of closure of duty free shops and of the agreed 2003 draft budget. Based on these actions, our policy proposals, and our firm commitment to strengthen performance under the arrangement, we request completion of the first review under the PRGF arrangement.

3. The Government and the Bank of Albania believe that the policies outlined in the attached MEFP provide a sound basis for achieving our program targets. During the period of this arrangement, Albania will consult with the IMF on the adoption of any further measures that may be appropriate, at the initiative of the Government or Bank of Albania, or whenever the Managing Director of the IMF requests such a consultation. In addition, the authorities will provide the IMF with such information as the IMF may request in connection with the implementation of the program. We will continue to conduct bi-annual reviews with the Fund under the PRGF arrangement, the second before end-July 2003 and the third before end-January 2004.

4. Moreover, after the period of this arrangement and while Albania has outstanding financial obligations to the IMF arising from loan disbursements under this arrangement, Albania will consult with the IMF from time to time on economic and financial policies, at the initiative of the Government or Bank of Albania or whenever the Managing Director of the IMF requests such consultation. These consultations may include correspondence and visits of officials of the IMF to Albania or of representatives of Albania to the IMF.

Sincerely yours,

Fatos Nano
Prime Minister
Kastriot Islami
Minister of Finance
Shkëlqim Cani
Governor, Bank of Albania


Supplementary Memorandum on Economic and Financial Policies
of the Government of the Republic of Albania for 2002–03
Under a Three-Year
Poverty Reduction
and Growth Facility (PRGF) Arrangement

I. Background

1. This memorandum describes our economic program for the period October 2002-June 2003. It supplements the June 2002 memorandum, which also outlined our medium-term strategy for 2002-05, consistent with our November 2001 PRSP, entitled National Strategy for Socio-Economic Development (NSSED or GPRS).

2. The change in government in July 2002 has not weakened our commitment to reform and the program. While political developments during the past year, coordination problems within the successive governments, and the difficult overall environment in 2002 have had an adverse impact on policy implementation, we remain fully committed to the program. We are giving priority to reversing past slippages, improving policy coordination and accelerating reforms aimed at fostering economic growth, improving governance, reducing corruption, and promoting European integration.

3. Macroeconomic stability has been maintained since the start of the current PRGF-supported program. Inflation has remained under control, although—owing to statistical and supply-side factors, in the context of strong demand—it has been mostly above its 4 percent target ceiling during the past year. Monetary stability was interrupted in March and April by a bank run, but we responded appropriately and deposits have started to recover. However, as a result of electricity shortages, recent floods, and spending cuts, growth has moderated to around 4½ percent to 5 percent in 2002. The current account is now estimated to have deteriorated to 8¾ percent of GDP in 2002, due to weak export and tourism performance. The exchange rate has been stable following its effective depreciation in the second quarter.

4. However, fiscal performance has been mixed, with shortfalls in tax and customs receipts. Collection targets have been missed almost consistently during 2002, despite improvements in the second half of the year. Political uncertainties and other exogenous factors have caused delays in efforts to expand the tax base—in the context of ambitious targets and lower-than-projected GDP growth. The impact on the deficit, however, has been broadly offset by difficulties in implementing planned investments. Consequently, net credit to government stayed below the program ceiling at end-September (performance criterion). The duty-free shops at land border crossings have been prevented from selling cigarettes and alcoholic beverages since July 2002, but we regret that more time has been needed to secure parliamentary approval for their full closure and request a waiver for missing the related structural performance criterion. Also, new environmental and agricultural taxes, initially scheduled for September 2002, will now be introduced within the context of the 2003 budget.

5. Following delays in a number of areas, we are strengthening our structural reform efforts. Although we met all prior actions for the IMF's June Board meeting, and several benchmarks under the PRGF arrangement, we encountered difficulties concerning some key structural measures. Despite our concerted efforts, no buyer could be selected for the Savings Bank, as the two interested foreign banks withdrew from the bidding process. In addition, Albtelekom's various financial and legal claims have not been settled yet, complicating its eventual privatization. Issuing government securities with a 2-year maturity was delayed from June to October due to legal complications. We have made some progress in reconciling public sector inter-enterprise arrears, but the process requires more time than expected. In the electricity sector, several monthly targets for reducing losses and improving collection have been missed since May 2002, in part owing to the accumulation of new arrears by the water companies vis-à-vis the electricity company (KESH).

II. Objectives and Policies

A. Overall Strategy

6. In line with the NSSED, our macroeconomic and structural policies will continue to focus on promoting growth and reducing poverty. We will aim to establish better conditions for private sector activity through: (i) ensuring macroeconomic stability; (ii) addressing infrastructural weaknesses (including electricity shortages); (iii) intensifying dialogue with the private sector to create a more business-friendly and transparent environment; (iv) improving governance; and (v) strengthening the financial system. Expenditure policies will complement efforts to promote growth by enhancing the focus on—and effectiveness of—priority spending. We plan to finalize an NSSED progress report by April 2003, which will focus on improving the costing and prioritization of spending plans. Monitoring and evaluation capacity is being strengthened in line ministries to improve the availability and analysis of policy-relevant data. We will make efforts to address the serious deficiencies in data collection, which hamper well-targeted policy design. As INSTAT bears the primary responsibility for this task, we have increased its resources in the 2002 and 2003 budgets. We will give top priority to improving communication and coordination among various ministries and agencies to enhance policy implementation and program monitoring. A fiscal Report on Observance of Standards and Codes in February 2003 will help identify further improvements in fiscal policy design, transparency, and data provision.

B. Macroeconomic Framework

7. In light of recent developments, the macroeconomic framework for 2002-05 has been revised. Overall, the macroeconomic outlook remains favorable. However, owing to adverse effects from the electricity situation, limited foreign investment, and the data constraints noted above, projected real GDP growth has been revised down from 7 percent to around 6 percent during 2003-05. The fiscal outlook has been adjusted to incorporate lower projections for tax and privatization receipts, with revised spending plans and lower overall fiscal deficits of 6½ percent of GDP in 2003 and 6 percent of GDP in 2004. The lower tax revenue projections are motivated by slippages during 2002, the projected growth slowdown, and the findings of a recent IMF Fiscal Affairs Department (FAD) mission. Inflation is expected to stay within its 2-4 percent target range in 2003 and beyond, supported by cautious monetary policies, and reserve coverage is projected to remain above 4½ months of imports. Although the current account deficit is expected to narrow by 1¾ percent over the program period, the deterioration during 2002 highlights the importance of addressing weaknesses in foreign investment and the export sector. The overall outlook is subject to several risks, including uncertain electricity provision and fragile financial sector confidence. We will monitor developments closely and consult with Fund staff regarding appropriate revisions to the macroeconomic outlook if necessary.

C. Fiscal Policy

8. The 2003 budget envisages an overall deficit of 6½ percent of GDP and domestic borrowing of 2¾ percent of GDP. Budgeted tax and customs receipts are now targeted to increase by about 15 percent relative to the estimated 2002 outcome—to 17.1 percent of GDP, compared with 18 percent of GDP under the program. While we remain fully committed to gradually raising tax compliance, slippages in 2002 have prompted us to re-evaluate the current strategy. Against this background, the increase in budgeted revenue relative to 2002 is based on both tax policy measures in the 2003 budget and further improvements in tax and customs administration. In addition, the budget assumes no privatization receipts from the sales of Albtelekom or the Savings Bank during 2003. The ceiling on domestic borrowing has been raised by ½ percent of GDP relative to the June program to limit the impact of these changes on essential spending under our poverty reduction strategy. Nevertheless, expenditures will only increase moderately relative to 2002. Foreign financing will consist mainly of resources provided on concessional terms. As a prior action to completing this review, the 2003 budget, in line with the policies in this memorandum, will be approved by parliament. In view of the uncertain prospects for GDP growth, and tax and privatization receipts, we will ask line ministries for clear prioritization of all projects in line with the NSSED, in the event that the budget may need to be re-assessed.1

9. We will improve tax and customs revenue collection on the basis of our medium-term revenue framework and the recommendations of the recent FAD mission. Further strong reforms are needed to modernize our tax and customs administrations, and fight more effectively fiscal evasion and smuggling. As a result, we are strengthening and expanding the strategy laid out in our June 2002 memorandum. We agree with the FAD mission's argument that the focus on revenue targets should not compromise reform efforts, and that the transparency and relative simplicity of our tax system should be maintained. In this context, we will strengthen our tax and legal systems to raise tax compliance over the medium term, and will not introduce any scheme that would undermine such efforts or raise the potential for money laundering and other illegal activities. Furthermore, parliament will approve the draft law on the closure of duty-free shops (prior action for the first review).

10. We will execute the following measures for raising tax compliance and attaining the targeted revenue increase in 2003. Regarding tax and social insurance, we will:

  • Shift responsibilities for the collection of social insurance to the Tax Department (TD), starting with the clients of the large taxpayer unit (end-September 2003) and large nonbusiness payers of social insurance (end-December 2003). To this end, we will strengthen cooperation between the TD and Social Insurance Institute, including by undertaking complementary measures agreed with the World Bank to help resolve administrative hurdles. We will prepare monthly reports on measures taken.

  • Implement fully a new function-based organization structure in the TD (end-February 2003) and recruit around 40 additional appropriately skilled staff in the TD's headquarters (structural benchmark; end-May 2003).

  • Reduce the rate of interest for late payment to a more commercially realistic level (for example, 3-4 percentage points above annual average bank lending rate, with periodic re-assessments) and ensure consistency between interest rate charges for social insurance and other taxes.

  • Establish formal tax policy and revenue forecasting units within the Ministry of Finance (MoF) (end-June 2003).

  • Complete implementation of new computer administration systems for profit taxes (end-June 2003) and small business tax and excise (end-September 2003).

  • Raise the number of registered taxpayers to 57,000 by mid-2003.

In relation to tax policy, we will:

  • Introduce a new excise law (by end-June, 2003) aimed at (i) bringing most excise rates close to EU standards and aligning them with the existing customs code; and (ii) enhancing administrative procedures, including for tax assessment, the appeals process, the approval process of establishing bonded warehouses for excisable goods, and search and inspection of sites suspected of evading excise taxes. Introduce environmental and agricultural land ownership taxes in the 2003 budget.

In the area of customs administration, we will:

  • Develop an overall strategy for combating customs fraud and corruption based on effective direction to field units, an enhanced role for regional offices, cooperation with the TD, and internal audits (end-March 2003). Enhance cooperation between the Customs Department (CD) and TD to fight evasion through underinvoicing. An action plan was adopted in June 2002 and a report is being prepared.

  • Establish a post-clearance control unit of up to 10 senior inspectors, concentrating on valuation, classification, origin, exemption, and suspension claims (structural benchmark; end-May 2003), while continuing to regularly update the reference prices file.

  • Complete implementation of ASYCUDA computer administration system in the Tirana custom house and Durrës port (end-September 2003).

  • Maintain the quarterly reporting on corrective measures being taken to deal with problems identified by internal audit function.

11. We will enhance our efforts to improve relations with taxpayers and reform the appeals procedures. We will extend the tax base to reduce pressure on the limited pool of existing taxpayers. To ensure the fair application of tax legislation, we will establish taxpayer service centers in the TD and CD, and each local tax branch, and create mechanisms to speed up VAT refunds. We will set up a working group, comprising representatives of the MoF, TD, and business community, to strengthen the independent appeals tribunal for resolving tax disputes. We will revise the procedures and manuals for the enforced collection of all taxes (including the freezing of bank accounts) to comply with the following principles, unless there are extraordinary circumstances pertaining to a particular taxpayer: (i) all overdue tax liabilities will be subject to initial collection action and respect for taxpayers' right of appeal before enforced collection measures are initiated; (ii) enforced collection measures will not be initiated if the liability is less than 30 days overdue or is the subject of an appeal; and (iii) taxpayers will be given 30 days from the date of notification of an appeal decision before further collection action is taken. Procedures for the initiation and conduct of enforced collection action will be disseminated publicly and their operation subject to oversight by the taxpayers' consultative forum to be established (structural benchmark, end-May 2003).

12. In the 2003 budget, we will continue our efforts to reorient expenditures toward NSSED priorities. In particular:

  • We intend to increase expenditure allocations for health and education by about 15 percent relative to the 2002 outturn, and, in consultation with the World Bank, introduce specific measures to improve access by the poor to health care.

  • The wage bill will not increase in 2003 as a share of GDP, implying a real increase of up to 6 percent. Of this, over 4 percent is already locked in by the carry-over from salary increases in 2002, limiting the room for new salary increases in 2003. Within this envelope, the sectoral allocation of the salary increases will be determined in consultation with the World Bank. To further assist efforts at building a more effective public administration, a database on all employees is becoming fully functional.

  • The quality and motivation of teachers and healthcare workers will be strengthened by reducing wage differentials vis-à-vis the private sector, increasing wage differentiation within these sectors, and conducting specific training programs. To this end, the 2003 budget envisages further salary increases in health and education by around 5 percent in real terms.

  • We will continue to improve the targeting of allocations for social assistance, including through completing a World Bank-supported study on social safety nets.

  • Electricity import subsidies will be limited to Lek 3.4 billion in 2003. To increase transparency, we have included other subsidies as separate line items in the budget—specifically for the payment of arrears (Lek 1.6 billion) and the concession agreement with the Italian company, DARFO (Lek 0.4 billion). In addition, to ensure the full and timely payment of current obligations by the water companies to KESH, the budget includes an explicit subsidy to the water companies (including about Lek 0.6 billion for electricity) and a designated amount in the reserve fund (Lek 0.4 billion).

  • We will give local communities more decision-making authority within our program of decentralization, with further increases in grants, and will ensure that the pace of decentralization is in line with progress in developing administrative capacity.

  • To the extent possible, any net government obligations arising from the regularization of inter-enterprise arrears (see below) may be met from the reserve and contingency funds. We will otherwise use the reserve and contingency funds sparingly and in emergencies.

13. We will continue our efforts to improve expenditure management. To enhance the timeliness and quality of reporting foreign-financed capital expenditures, we will issue a new regulation (and ensure its implementation) requiring project-implementation units in line ministries to report on a monthly basis. We will continue with computerizing regional treasury offices to improve reporting—to be completed for the Tirana office in 2003 and for the entire project in 2004.

14. We will proceed to regularize inter-enterprise arrears. A procedure for settlement of inter-enterprise arrears has been put in place. With respect to large enterprises, we are in the process of finalizing the recording of these arrears, completing the reconciliation process, and signing bilateral Memoranda of Understanding specifying net overdue amounts as of December 31, 2001. As the next step, and in consultation with Fund staff, we will reduce the stock of these arrears through bilateral netting and determine the amount of arrears that can be cancelled through government assisted scheme for multilateral repayments of arrears. Public companies participating in this scheme will be required to enter into contractual arrangements with the government. We will design strategies for promoting the full and timely payment of all obligations contracted after December 31, 2001 (structural benchmark; end March 2003). For this purpose a special unit will monitor, and report to the Ministry of Finance and Economy, and line ministries, on a quarterly basis, the receivables and payables position of these companies. We will also assess the inter-enterprise arrears position of the smaller public enterprises, and if required, encompass these within our scheme.

D. Monetary Policy

15. Monetary policy will remain cautious, given the risks to inflation and with base money still elevated after the large-scale withdrawal of bank deposits. We will ensure that the independent position of the Bank of Albania (BoA) will not be compromised. The BoA will continue to conduct its monetary operations with the aim of keeping inflation within a 2-4 percent range, in the context of a flexible exchange rate regime, while smoothing excessive exchange rate fluctuations. The repo rate will remain our key policy instrument, while we will also seek to ensure compliance with NIR and NDA targets under the program. We will proceed with plans to strengthen data collection, conduct research on the determinants of inflation, and further refine our policy instruments, with technical assistance from the IMF's Monetary and Exchange Affairs Department (MAE).

16. The monetary program assumes continued monetary stability, inflation in line with the target, and a reserve-to-import ratio of about 4½ months. Velocity is projected to decline slightly, in part due to the redepositing of foreign currency withdrawn in March and April 2002. Moreover, the trend shift within broad money towards foreign currency deposits is expected to persist in 2003. The gradual return of depositors to the banking system is also reflected in limited base money growth in the first half of 2003.

17. The BoA will continue to strengthen banking supervision, in the context of the new Supervisory Development Plan, developed in consultation with the World Bank. The MoF will reinforce its efforts to combat money laundering. In both areas, technical assistance will be provided by a new MAE resident advisor.

18. The BoA will strengthen its control, accounting, and auditing systems, in line with the July 2002 safeguards assessment report. It will seek to ensure the timely implementation of the recommendations to: (i) guarantee the integrity of data reporting under the program; (ii) strengthen its internal auditing on the basis of the recommendations of the Financial Services Volunteer Corps; (iii) formalize the oversight of nonexecutive members of the Supervisory Council over the bank's auditing, internal control, and financial reporting; and (iv) ensure that any remaining deviation from International Accounting Standards is stated in the audit opinion, and disclose the financial implications. The BoA will continue to cooperate with the safeguards policy and provide updated documents and data as necessary.

E. Structural Policies

19. We will intensify efforts to improve the Savings Bank's and Albtelekom's marketability following privatization delays. With World Bank assistance, we are preparing an action plan to restructure the Savings Bank. Specific measures include: (i) transferring all pension functions to Albapost by end-March 2003 (structural benchmark); (ii) further efforts to move the bank's fiscal functions to other banks; (iii) further consolidation of rural offices; (iv) strengthening its IT network; and (v) building the capacity for credit provision—although no credit will be extended before privatization except on a pilot basis and with the prior approval of the BoA, and World Bank and Fund staff. In view of the partial exemption of the bank from the Competition Law, we will, by end-June 2003, prepare draft legislation to avoid abuse of market power. Regarding Albtelekom, we will submit a request for deregistration of its joint venture with New World to the Tirana court by end-January 2003. We will also settle the company's remaining unresolved financial claims by end-March 2003 (structural benchmark). In the oil sector, we will bring all parts of ARMO and SERVCOM to the point of sale by end-2003.

20. Recent slippages in electricity sector reform will be addressed without delay. We are making every effort to ensure that the end-December 2002 and end-March 2003 targets under the Action Plan are met. Meeting these targets is critical also for maintaining essential donor support. To this end, we have stepped-up disconnections in case of nonpayment. Also, the MoF will monitor carefully the financial situation of KESH to help ensure compliance with the collection targets and to avoid unexpected financial problems—in particular, the emergence of new arrears or slippages in counterpart financing. We remain fully committed to phasing out subsidies to KESH for electricity imports by the end of 2004. We will adopt a new Action Plan for 2003-04, with further measures and targets to improve bill collection and reduce losses. Electricity prices will be increased as of January 1, 2003, and we intend to introduce the next price increase no later than by January 1, 2004. Further price increases will be based on a World Bank-financed study and will be accompanied by measures to alleviate the impact on vulnerable households. The installation of electricity meters is key to reducing excessive electricity demand and we aim to complete the process by mid-2004. We will not grant any further concessions to investors that include reduced or fixed electricity tariffs. Regarding power generation capacity, we will only proceed with new electricity generation projects in consultation with the World Bank and will first focus our efforts on thermal power.

21. Ongoing efforts serve to strengthen and modernize our financial system. The deposit insurance scheme will become operational by end-January 2003. We have improved and expanded the accessibility of the BoA's windows for selling treasury bills. We will also encourage the direct sale of treasury bills by commercial banks and the MoF will actively support their marketing. With World Bank assistance, we will strengthen the supervision of the insurance market and establish a credit information bureau within the BoA. For small firms, access to credit will be facilitated by a partial guarantee scheme. Further improvements should result from the adoption of the new Bankruptcy Law in 2002.

22. Improving the business environment, strengthening the export sector, and attracting foreign and domestic investors are crucial for sustained growth. We will strengthen the consultation process with the private sector, including by reinforcing the role of the Business Advisory Council. We are establishing an investment promotion agency. We will consult with the World Bank before establishing export promotion and small business development agencies to ensure that these initiatives do not lead to increased bureaucracy or duplication. We will, in cooperation with the World Bank's Foreign Investment Advisory Service, conduct a study of administrative barriers by end-March 2003 and design an action plan for implementing its recommendations. In order to create better conditions for developing the agricultural sector, we will prepare a law to regulate private land ownership, complete the registration of most lots by 2004, and establish offices for land in every district.

23. We will give a high priority to improving the quality and coverage of economic statistics, using the GDDS as a framework. We will ensure that the first official National Account Statistics for 1998-2000 (including full documentation of the employed methodology and data sources) are published by end-January 2003. We will improve the quality of these statistics during 2003 and 2004 (planned to be financed in part by a grant from the Italian government) including through increasing the use of surveys and recruiting two additional technical staff. We will also make concerted efforts to strengthen the provision of short-term indicators of economic activity, essential for dependable policy analysis. To support these efforts, we will strengthen statistical reporting by the line ministries and other agencies to INSTAT and vice versa. In this context, to upgrade the exchange and disclosure of information, macroeconomic analysis, and methodologies, a Macroeconomic Committee has established a quarterly framework for prompt data sharing, involving other ministries as appropriate (in particular, the Ministry of Agriculture). We will monitor the adequacy of this framework on a regular basis. The new Law on Statistics will strengthen INSTAT's access to data, and approval by Parliament is foreseen before end-March 2003. We will examine the need for a further increase in INSTAT's budget in order to ensure adequate staffing. The BoA will begin to identify possible sources of data on foreign direct investment and private sector external debt.

F. External Policies

24. With the envisaged foreign support, we expect that the balance of payments position will remain sustainable. Creating a more business-friendly environment will be important in improving our external position through attracting foreign investors and strengthening exports and tourism. We will ensure external debt sustainability by observing ceilings on nonconcessional borrowing (performance criterion). We will reinforce efforts to strengthen evaluation and coordination of foreign-financed projects—including through quarterly reporting by line ministries on proposed foreign borrowing over a 3-year horizon.

25. We are committed to eliminating our external arrears to official creditors during the PRGF-supported program. In this context, the arrears to Greek companies were repaid in June and the rescheduling agreement with China (post-1978 arrears) was finalized in November. A new comprehensive set of criteria for dealing with external arrears has been submitted to Parliament and the MoF will continue quarterly reporting on these arrears (structural benchmarks) (the BoA will complete the transfer of all related documents before end-2002). To work toward accepting our Article VIII (Sections 2, 3, and 4) obligations, we plan to submit to Parliament, by mid-2003, rescheduling agreements relating to arrears already reconciled. We will also enhance efforts to regularize arrears to private creditors.

26. We are committed to maintaining a liberal trade regime and enhancing regional cooperation. We are working toward concluding the scheduled regional free trade agreements and have sought advice from the WTO regarding the consistency of the recently imposed 1 percentage point import surcharge with our WTO membership commitments.

G. Program Monitoring

27. The second review under the PRGF-supported program will be based on end-March 2003 quantitative performance criteria and end-June 2003 indicative targets (see Table 1 and the Technical Memorandum of Understanding). Prior actions and structural benchmarks are presented in Table 2. Performance criteria and indicative targets for end-September and end-December 2003 will be set at the time of the second review. During the program period, Albania will not impose or intensify restrictions on the making of payments and transfers for current international transactions, or introduce multiple currency practices, or conclude bilateral payments agreements inconsistent with Article VIII, or impose or intensify import restrictions for balance of payments reasons.

Table 1. Albania: Quantitative Performance Criteria
and Indicative Targets for 2001-031






   (In billions of Lek)
Ceiling on net domestic credit
   to the government3
 237.5 3.5 7.86.7 9.29.5 19.5 5.0 9.0
Ceiling on net domestic assets
   of the BOA4
 78.1 6.8 10.311.2 5.012 17 19 20
Indicative target for revenues
   collected by Tax Department5
 91 22 4749 35.939 110 13.9 28.6
Indicative target for revenues
   collected by Customs
        36.339 56 12.9 26.9
Indicative targets for Social
   Insurance Revenues5
 . . .      18.7. . . 26 7.3 14.7
   (In millions of U.S. Dollars)
Floor for net international
   reserves of the BOA4,6
 542.6 4.8 2.9-12 28.14 16 18 18
Ceiling on contracting or
   guaranteeing of public and
   publicly-guaranteed non-
   concessional external debt7,8
 . . . 26.3 56.5100 56.2130 160 170 180
    of which: 1-5 years  . . .0 00 00 0 0 0
Ceiling on public and publicly-
   guaranteed external debt with
   original maturities up to and
   including 1 year9
 . . . 0 00 00 0 0 0
Nonaccumulation of new
   external payments arrears,
   excluding interest on pre-
   existing arrears9
 . . . . . . 00 00 0 0 0

1The performance criteria and indicative targets envisaged under the program, and their adjustors, are defined in the Technical Memorandum of Understanding (TMU).
2Performance criteria, except for revenues collected by the Tax and Customs Department, which are indicative targets.
3For 2002: cummulative changes as of end-December 2001. For 2003: cummulative changes as of end-December 2002. The targets of 2002 assume privatization receipts of Lek 1.1 billion and budget support of Lek 9 billion
(evaluated at an exchange rate of 144 lek per dollar).
4Cummulative changes as of end-December 2001.
5The end-March and end-June 2003 targets are based on cummulative changes as of end-December 2002.
6Derived using the end-December 2001 exchange rates.
7This performance criterion applies to the contracting or guaranteeing by the central government or the Bank of Albania as specified in the TMU.
8The end-March and end-June 2003 ceilings for contracting nonconcessional debt are tentative, based on preliminary and partial information from the authorities. Moreover, the limits do not include borrowing for the thermopower plant project being developed in consultation with the World Bank, which is expected to be reflected in the program through either excluding it from the debt limits on the basis that the concessionality of the total financing package exceeds 35% or explicitly including the nonconcessional financing components in these borrowing limits. Further analysis of the financing terms of prospective infrastructure projects terms and their debt implications will be undertaken before finalizing the proposed limits.
9These performance criteria apply on a continous basis.

Table 2. Albania: Prior Actions and Structural Benchmarks
under the PRGF Arrangement

 Measures Test-date

A. Prior Actions for the First Review  
1. Parliament to approve the 2003 budget consistent with this Supplementary Memorandum of Financial and Economic Policies (MEFP, ¶8).  
2. Parliament to pass legislation to close duty-free shops at all land crossings in border areas to reduce scope for smuggling and tax evasion (MEFP, ¶9).  
B. Proposed Structural Benchmarks for the Second Review  
1. To strengthen tax and customs administration: recruit around 40 additional appropriately skilled and experienced staff in the Tax Department's headquarters (MEFP, 10); revise procedures and manuals for the enforced collection of taxes (MEFP, 11); and establish a post-clearance control unit with a staff of up to 10 senior inspectors, concentrating on valuation, classification, origin, exemption, and suspension claims, while updating reference prices regularly (MEFP, 10). End-May 2003
2. Determine the amount of domestic arrears within the public sector that can be cancelled through government-assisted multilateral repayments and design strategies for promoting the full and timely payment of all obligations contracted thereafter (MEFP, 14).  End-March 2003
3. To promote the privatization process: complete the transfer of pension functions from Savings Bank to Albapost (MEFP, ¶19); and settle the remaining financial claims of Albtelekom (MEFP, ¶19). End-March 2003
4. Prepare quarterly reports (within one month of the end of each quarter) on the stock of external arrears and progress in clearing these arrears (MEFP, ¶25). Throughout

1Higher privatization receipts up to Lek 3.6 billion (0.5 percent of GDP) will be used to pay down domestic debt and receipts above that amount may be used for higher spending consistent with NSSED priorities.

Technical Memorandum of Understanding

This memorandum defines the quantitative benchmarks and performance criteria established in the Memorandum of Economic and Financial Policies for October 2002-June 2003 (MEFP).

A. Net Domestic Credit to the Central Government

1. For the purposes of the program, the central government covers the State Budget, the Social Security Institute (SSI), and the Health Insurance Institute (HII).

2. Net domestic credit to the government (NCG) is defined as the sum of credits in lek and in foreign currency, except for onlending of foreign project loans to all parts of the central government as defined above, including Treasury bills and bonds held by the Bank of Albania, domestic commercial banks, and other domestic lenders (including insurance companies, other firms, and households), less the sum of central government deposits with the banking system (but excluding foreign currency deposits related to foreign financed projects), and the deposits of the SSI and the HII.1 Credits comprise bank loans and advances to the government (excluding advances on profit transfers by the Bank of Albania), holdings of government securities, due but unpaid interest, and negative balances in government deposits with banks.

3. The component of the domestic credit to government in the form of securities will be calculated based on data on their outstanding stock valued at issue price, with the adjustment for the amount held by the units of central government as defined above (in particular, the SSI and the HII). Sales of Treasury bills will be counted excluding the discount. Reported repayments of Treasury bills and other government securities will not include interest payments, either as coupon interest or the discount. Those components of net domestic credit to the government denominated in foreign currencies are to be valued as stipulated in the GFS. Data on other components of credit to government, if any, will be reported by the Bank of Albania.

4. According to the above definition, the level of net domestic credit to government was Lek 237.8 billion at end-December, 2001.2 Gross loans were composed of (i) total outstanding T-bills at issue price in the amount of Lek  241.7 billion, of which Lek  67.8 billion was held by the Bank of Albania, Lek 164.5 billion by commercial banks, and Lek 9.5 billion by other domestic lenders; and (ii) other government lek securities, loans, and other claims on government in the amount of Lek 4.0 billion. From these gross loans, the following items were deducted: (i) central government deposits (excluding social security funds) in the amount of Lek 0.9 billion; and (ii) SSI and HII deposits and T-bill holdings in the amount of Lek 7.1 billion.

5. The limits on the change in net domestic credit to the government will be cumulative from end-December 2001.

B. Net Domestic Assets

6. The net domestic assets (NDA) of the Bank of Albania are defined as the difference between reserve money—defined as the sum of currency issue (less lek notes and coins held by the Bank of Albania) and commercial bank reserves held by the Bank of Albania—less the net international reserves of the Bank of Albania (Section C), with all foreign currency assets and liabilities valued in local currency for program monitoring purposes at an exchange rate at end-December 2001. Under this definition, the level of the NDA was Lek 79.4 billion as of end-December 2001. The NDA limits will be cumulative changes from end-December 2001 and will be monitored from the accounts of the Bank of Albania.

C. Net International Reserves

7. Net international reserves (NIR) are defined as reserve assets minus reserve liabilities of the Bank of Albania. Reserve assets are readily available claims of the Bank of Albania on nonresidents denominated in foreign convertible currencies, and held for the purpose of meeting balance of payments financing needs, intervention in exchange markets, and other purposes. They include Bank of Albania holdings of monetary gold, SDRs, Albania's reserve position in the IMF, foreign currency cash, and deposits abroad. Excluded from reserve assets are any assets that are pledged, collateralized, other otherwise encumbered; claims on residents; precious metals other than monetary gold; assets in nonconvertible currencies; illiquid assets; and claims on foreign exchange arising from derivatives in foreign currencies vis-à-vis domestic currency (such as futures, forwards, swaps, and options). Reserve liabilities shall be defined as foreign exchange liabilities to residents and nonresidents of the Bank of Albania, irrespective of their maturity. They include: foreign currency reserves of commercial banks held at the Bank of Albania; all credit outstanding from the IMF; commitments to sell foreign exchange arising from derivatives (such as futures, forwards, swaps, and options); and all arrears on principal or interest payments to commercial banks, suppliers, or official export credit agencies. Excluded from reserve liabilities are the government's foreign currency deposits at the Bank of Albania.3 Reserve assets and reserve liabilities will both be expressed in U.S. dollars.

8. During this program, for monitoring purposes, the exchange rates of the SDR and non-dollar currencies will be kept at their end-December 2001 levels and holdings of monetary gold will be valued at SDR 35 per ounce. Excluded from gross international reserves are holdings of nonconvertible currencies, claims on nonresident financial institutions denominated in nonconvertible currencies, and other claims which are not readily available.

D. Adjusters for NCG, NDA, and NIR

9. The NCG ceiling, NDA ceiling and NIR floor are defined on the assumption that privatization proceeds will amount, on a cumulative basis, from January 1, 2003 to:

    End-March 2003Lek 0.660 billion
    End-June 2003Lek 0.799 billion

The NIR floor will be adjusted upward (downward) and the NDA ceiling adjusted downward (upward) by any excess (shortfall) in these receipts. The NCG ceiling will be adjusted downward by any excess in these receipts up to ½ percent of GDP (Lek 3.6 billion). It will remain unchanged for any additional excess. The NCG ceiling will be adjusted upward by any shortfall in these receipts.

10. The NCG, NDA, and NIR targets are defined based on the assumption that foreign budgetary and/or balance of payments financing (excluding IMF financing and project and commodity loans or grants, or other aid) will amount, on a cumulative basis, from January 1, 2003 to:

    End-March 2003US$0 million
    End-June 2003US$0 million

In cases when total foreign financing exceeds this projection, the target for the net domestic credit to the government and the net domestic assets of the Bank of Albania will be adjusted downward, and for the net international reserves upward, with the proviso that the upward adjustment to the NCG and NDA ceilings and the downward adjustment to the NIR floor should not exceed US$15 million4.

11. The NDA ceilings will be also adjusted to reflect the impact of any change in the required reserve ratio of commercial banks with the Bank of Albania.

E. External Debt and Arrears

12. As set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-00/85) August 24, 2000), the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property. Arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

13. The limit on medium- and long-term external debt applies to the contracting or guaranteeing by the central government or the Bank of Albania, of new nonconcessional external debt with an original maturity of more than one year, with sublimits on external debt with an original maturity of more than one year and up to and including five years. It applies not only to debt as defined in paragraph 12 of this memorandum, but also to commitments contracted or guaranteed for which value has not been received. External debt will be considered to have been contracted at the point the loan agreement or guarantee is ratified by the Albanian parliament. Excluded from the limits are refinancing credits and rescheduling operations (including the deferral of interest on commercial debt), credits extended by the IMF, and credits on concessional terms defined as those with a grant element of at least 35 percent. The grant element is to be calculated using the OECD Commercial Interest Reference Rates (CIRRs): for maturities of less than 15 years, the grant element will be calculated based on six-month averages of CIRRs; and for maturities longer than 15 years, the grant element will be calculated based on ten-year averages. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time the contract or guarantee becomes effective.

14. The limit on short-term external debt applies on a continuous basis to the stock of short-term external debt owed or guaranteed by the central government or the Bank of Albania, with an original maturity of up to and including one year. It applies to debt as defined in paragraph 12 of this memorandum. Excluded from the limit are rescheduling operations (including the deferral of interest on commercial debt) and normal import-related credits. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time the contract or guarantee becomes effective.

15. A continuous performance criterion applies to the nonaccumulation of new external payments arrears on external debt contracted or guaranteed by the central government or the Bank of Albania. External payment arrears consist of external debt service obligations (principal and interest) falling due after March 31, 2002 and that have not been paid at the time they are due, as specified in the contractual agreements. Excluded from the prohibition on the accumulation of new arrears are: (i) arrears arising from interest on the stock of arrears outstanding as of March 31, 2002; and (ii) external arrears that are subject to debt rescheduling agreements or negotiations.

F. Tax Revenues

16. Collection of revenues by the Tax and Customs Departments and social insurance contributions will be monitored on the basis of quarterly indicative floors.

G. Monitoring and Reporting Requirements

17. Performance under the program will be monitored from information supplied monthly to the Fund by the Bank of Albania and the Ministry of Finance. The following information will be communicated monthly to the Fund by the Ministry of Finance: the summary fiscal table, including the overall budget deficit, on a cash basis; their issuance of Treasury bills including gross value and cash received; and privatization receipts. The Bank of Albania will communicate monthly to the Fund: the balance sheets of the Bank of Albania, and the consolidated accounts of the commercial banks; the monetary survey; the net domestic credit to the government; the NFA of the Bank of Albania; the foreign exchange cashflow of the Bank of Albania, including the level of official reserves; daily average exchange rates; and trade flows. The following information will be communicated quarterly to the Fund by the Ministry of Finance: information on the contracting and guaranteeing of new debt; information on the stock of short term, and on medium- and long-term debt; and, with assistance from the Bank of Albania, information on all overdue payments on short-term debt and on medium- and long-term debt. The Bank of Albania will also communicate to the Fund periodic updates of balance of payments estimates.

1Nonbank domestic lenders comprise both firms (including insurance companies) and households. For small lenders, a Treasury bill window is available at the central bank.
2This amount differs from "claims on government (net of deposits)" in the standard monetary aggregates table, as the latter excludes nonbank lending and includes foreign currency deposits.
3This exclusion is justified by current procedures in Albania, whereby the government's foreign currency receipts are deposited in a blocked account at the Bank of Albania and the funds are transferred to the government's lek account before being spent. A change in this procedure, would require revisiting the NIR definition.
4For the NCG adjuster, the lek equivalent of deviations from the programmed amounts in terms of dollars is converted at an exchange rate of Lek 145 per dollar, in order to ensure consistency with the budget projections.