Republic of Montenegro and the IMF

Republic of Serbia and the IMF

Press Release: IMF Executive Board Completes Fourth Program Review and Eighth Financing Assurances Review Under an Extended Arrangement with Serbia and Montenegro, and Approves US$95.6 Million Disbursement
December 15, 2004

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Serbia and MontenegroLetter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

November 29, 2004

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

Mr. Rodrigo de Rato
Managing Director
International Monetary Fund
Washington DC 20431

Dear Mr. de Rato:

Firm implementation of our medium-term economic program supported by the Fund under the Extended Arrangement (EA) has permitted good progress in stabilization and reform. To ensure continued progress and address new challenges, we have updated our economic and policy targets for 2004-05, as described in detail in the attached Memorandum on Economic and Financial Policies. On this basis, we request: (a) completion of the fourth semi-annual review (including the eighth financing assurances review) under the EA; (b) waivers for the non-observance of an end-June, 2004 performance criterion (the passage of the Serbian bankruptcy law) and two end-September, 2004 performance criteria (contracting or guaranteeing new nonconcessional external debt from multilateral creditors by the public sector in Montenegro; and non-assumption by the public sector of enterprise debt to banks in Montenegro); (c) the purchase of SDR 62.5 million following the completion of the fourth review; and (d) a rephasing of purchases for the remainder of the program by combining the tenth and eleventh purchase, to become available upon completion of the fifth review which would be postponed to cover the end-December 2004 test date. The non-observed quantitative performance criteria for which waivers are requested were missed by small margins and the Serbian bankruptcy law was adopted with a short delay. We are taking measures to improve policy implementation in these areas.

We believe that the policies and measures described in the attached memorandum are sufficient to achieve our program objectives, but we stand ready to take timely additional measures and seek new understandings with Fund staff, as necessary, to keep the program on track. We will remain in close consultation with the Fund staff on the adoption of these measures, and in advance of any revisions to the policies contained in the attached MEFP in accordance with the Fund's policies on such consultations. We will provide all information to the Fund that it requests to assess the implementation of the program. The program will continue to be reviewed by the Fund, with the discussions for the next review, together with the Article IV consultation, expected in January 2005. The next review will focus on progress in structural reforms (including budgetary employment reduction, enterprise restructuring and privatization, bank reform), and on the implementation of fiscal, monetary, incomes and exchange rate policies. Moreover, each purchase under the arrangement will continue to be subject to a review of the financing of the program.

Yours sincerely,

Predrag Ivanović
Minister of Foreign Economic Relations
Serbia and Montenegro


Miroljub Labus
Deputy Prime Minister
Republic of Serbia


Miroslav Ivanišević
Deputy Prime Minister
Republic of Montenegro


Mladjan Dinkić
Minister of Finance
Republic of Serbia


Radovan Jelašić
National Bank of Serbia


Igor Lukšić
Minister of Finance
Republic of Montenegro


Ljubisa Krgović
Central Bank of Montenegro

Memorandum of Economic and Financial Policies

I. Introduction

1. This memorandum updates and supplements the Memorandum of Economic and Financial Policies (MEFP) attached to the Letter of Intent of May 21, 2004. It reports on recent developments under the program supported by the Extended Arrangement (EA) approved in May 2002 and updates the economic objectives and policy agenda for the remainder of 2004 and for 2005.1

2. The performance under the program — supported by the Extended Arrangement with the Fund — is broadly on track. While four end-June performance criteria (PCs) were not met, all but two end-September PCs were observed. The end-June ceilings for the NDA of the central bank and bank credit to government in Serbia were missed, but observed at end-September. In addition, the end-June PC on contracting or guaranteeing new nonconcessional external debt from multilateral creditors was breached by Montenegro; this PC, and that on debt guarantees was also breached at end-September. The Montenegrin government is committed to avoiding similar breaches in the future. The end-June structural PC for Serbia on electricity tariffs was met on time, while that on the bankruptcy law was met with a slight delay owing to scheduling difficulties in Parliament. The end-June and end-September indicative targets on the wage bill of state enterprises were exceeded. A number of additional indicative targets—on net credit to government, arrears, banking system NDA, and central government dinar deposits—were not met at end-June, with the latter two missed also at end-September, calling for improved policy implementation. End-June structural benchmarks on the VAT law and bank privatization, and recovery of banks assets were met (the latter with some delay). The end-September structural benchmarks in Serbia and Montenegro on asset recovery have not been met. Both governments are seeking to address these delays.

3. Strong growth in 2004 has been overshadowed by accelerating inflation and an increasing external imbalance.

  • Twelve-month inflation in Serbia rose to 11½ percent in September, driven by cost and demand factors, while inflation in Montenegro fell to 2.1 percent by August.

  • Real growth is likely to reach 6 percent led by a bumper crop in agriculture and solid industrial growth supported by output gains in recently privatized enterprises. Demand was boosted by an increase in consumption fed by an estimated 12 ½ percent increase in real wages through August in Serbia and rapid credit growth in both republics (especially in consumer lending and leasing).

  • Rapid growth of foreign currency deposits, along with an increase in foreign loans to banks in Serbia, have continued to fuel lending to the nongovernment sector, which rose by 30 percent in real terms in the 12 months ending in August—albeit from a low base. In Montenegro, credit growth in the year to August exceeded 40 percent.

  • The SM current account deficit deteriorated further in the first six months of 2004 compared to a programmed improvement, and is projected to reach 13 percent of GDP by year-end. Imports rose by 32 percent year-on-year especially of cars by more than 50 percent, while export growth lags behind. Higher-than-projected world oil prices account for about 0.7 percent of the projected higher external deficit. Private remittances continue to be high, projected at 14 percent of GDP in 2004, but FDI is expected to fall to 4 percent of GDP, reflecting a slowdown in privatization in the first half of the year. Net foreign reserves rose to US$3.5 billion (3.6 months of projected 2005 imports) at end-September 2004.

  • The debt dynamics will benefit from the recent completion of negotiations with London Club creditors, but the increase in the debt financing of the current account deficit raises concern. The London Club agreement implies a reduction of the debt to commercial banks of 62 percent, reducing the country's overall debt burden by 7 percentage points of GDP. However, an increasing share of the external deficit is financed by debt (about 37 percent) making the country more vulnerable to external shocks. The increase in foreign borrowing is keeping the debt/GDP ratio at a projected 58 percent at end-2004.

  • Confidence in the dinar has remained fragile, and the share of foreign currency deposits in total deposits has increased. The dinar has depreciated by 2 percent in real effective terms in the year through September.

4. Fiscal policy in Serbia was tightened after June to safeguard annual inflation and external balance targets, while tax reform advanced. Total revenue was broadly in line with the program at end-September, and expenditure has been under tight control since July, which corrected for higher than expected spending in the first six months. The shift towards indirect taxes advanced with the elimination of the wage bill tax (July 2004), rationalization of the social contribution rates and bases (July and September 2004), increases in excises on gasoline, diesel, and cigarettes (July 2004), a new lottery tax (July 2004), reduced corporate income tax to 10 percent (September 2004), and cancellation of the financial transaction tax (effective January 2005). The January 1, 2005 introduction of the VAT will further advance this shift. In Montenegro, total revenue fell below programmed levels despite strong VAT revenue performance, but prudent budget execution has kept the deficit in line with the program.

5. Monetary policy was also tightened at mid-year to rein in inflation and the widening external deficit. The NBS raised the interest rate on its bills during June-July, and increased the required reserve ratio by 3 percentage points from August. These measures tightened liquidity by about 0.6 percent of GDP.

6. The implementation of structural reforms has resumed since July. Serbian Parliament approved a package of 17 economic reform laws in mid-July. Privatization has recommenced with the issuance of tenders for 8 socially-owned enterprises. Financial sector reform is continuing—Jubanka has been offered in a public tender as programmed and its sale to a strategic investor is expected to be completed around the end of the year. Tenders for sale of Continental Banka and Novosadska Banka were published in late September. The conversion of all Paris and London Club as well as FFCD-related liabilities into state-owned equity in banks to be privatized is also essentially complete.

II. Economic Objectives and Policies

7. The economic objectives for 2004-05 and beyond reflect robust growth in incomes while addressing higher inflation and safeguarding a sustainable external position (Table):

  • Real GDP is projected to grow by 4½ - 5 percent in 2005, settling at 5 percent in subsequent years as restructuring-related output losses subside, privatization and enterprise restructuring continue, and cumulative FDI inflows reach higher levels.

  • End-period inflation will accelerate to 12-13 percent in 2004 due in part to one-off exogenous shocks, but is targeted to fall under 10 percent in 2005, and to gradually decline to low single digits over the medium term (inflation in Montenegro is projected to decline to 2½-3 percent in 2004, outperforming original forecasts, and is expected to remain in this range in 2005).

  • The external current account deficit (before grants) is projected to recede to 12 percent in 2005 as policies aimed at containing domestic demand take effect. Higher oil prices are estimated to account for about a percentage point of this deficit. To ensure external sustainability and remain consistent with expected financing, the deficit is projected to decline steadily thereafter based on a recovery of exports as structural reforms elicit a supply response and prudent policies strengthen competitiveness. As structural reforms accelerate and the business climate improves over the medium term, FDI inflows could play an increasing role in financing the current account deficit, allowing a gradual decline in reliance on foreign assistance and loans.

  • The import coverage of foreign reserves at end-2004 will remain unchanged from end-2003, with a view to guarding against possible risks and preparing for the projected rise in external debt service in the medium-term following the expiry of grace periods under debt restructuring agreements.

8. Economic policies will be geared to support sustainable growth while narrowing the external current account deficit. Fiscal policy and monetary policy will support current account adjustment while the health of the financial sector will be improved and structural reforms accelerated to increase export potential with the support of appropriate safety-nets.

Table 1. Macroeconomic framework




3d Review
3d Review

(Percentage change)
Real GDP Growth
4 - 5
4 - 5
4 - 5
Inflation (end period)
8 - 9
9 - 10
   Of which : Montenegro
(Percentage of GDP)
Domestic investment
Domestic savings
Current account deficit (before grants)
Gross official reserves (US $ billion)
In months of projected imports
Total external debt
Net external debt
Underlying net external debt1
Fiscal deficit

Sources: SM authorities; and IMF staff estimates.
1Underlying net debt excludes the impact of write-offs in London Club, other commercial, and official bilateral debt.

9. The PRSP process will continue to guide the development agenda and social policies. The PRSPs adopted by the Serbian and by the Montenegrin governments in late 2003 outline the key reforms. Social spending will be protected to provide a safety net for those affected adversely by reforms, while its efficiency will be enhanced through the improved targeting of benefits.

A. Fiscal Policy

10. Fiscal policy in 2004 and 2005 will continue to anchor the stabilization effort and improve medium-term sustainability. Fiscal policy will be tightened by 1.4 percent of GDP in 2004 and 1.2 percent (1.7 percent excluding redundancy payments) in 2005, largely through cuts in expenditures. Reflecting the tightened fiscal stance, prudently assumed privatization proceeds (1.6 percent of GDP), and foreign disbursements (1.1 percent of GDP), the fiscal program for 2005 envisages a build-up of government deposits equivalent to 0.6 percent of GDP. As in previous years, privatization proceeds beyond program targets will be used to reduce net government indebtedness—and if consistent with achieving program objectives and in consultation with the Fund in the context of program reviews—to cover investment and restructuring costs.


11. Fiscal policy for the remainder of 2004 will be tighter than programmed to reduce external vulnerabilities. To scale back government spending as agreed in the third review, the Parliament passed a budget amendment bill in October (prior action for the Fourth Review). The supplementary budget includes an additional cut of 0.2 percent of SM GDP in view of heightened pressure on the current account deficit in addition to budgetary reallocations in line with the understandings under the Third Review (MEFP paragraph 16). The supplementary budget (i) substantially increases allocations for the social funds to ensure timely payment of entitlements; (ii) allocates resources for payment to London Club creditors (2.5 billion dinars); and (iii) cuts spending relative to the appropriations in the 2004 Budget Law, notably subsidies to agriculture and transportation, net lending, bank restructuring, and goods and services. With these measures, the consolidated fiscal deficit of the Serbian general government is projected to decline from 3.0 percent of GDP in 2003 to 1.7 percent of GDP in 2004 (from 2.5 percent to 1.2 percent excluding FLFPs).2

12. Fiscal policy in 2005 will be further strengthened to support the stabilization effort. The overall deficit of the Serbian general government in the 2005 budget (whose submission to Parliament is a prior action for the Fourth Review) will be cut by 1.1 percentage points to 0.6 percent of GDP (a surplus of 0.1 percent excluding FLFPs).3 Since total revenue as a percentage of GDP is expected to fall in 2005 with the legislated reduction of the tax burden, expenditure cuts will bear the brunt of the adjustment while laying a foundation for further fiscal consolidation in the medium term. With a tighter deficit and projected privatization proceeds of 1.6 percent of GDP and net external disbursement of 0.9 percent of GDP, the budget sector is expected to reduce it demands on net domestic financing by 2.0 percent of GDP in 2005.

13. The tax burden will continue to shift from labor to consumption to increase savings, growth and job creation. A broadly revenue neutral two-rate VAT (standard rate 18 percent, reduced rate 8 percent) will replace the retail sales tax in January 2005. Fees and taxes on securities transactions will be eliminated by January 1, 2005. The various changes in taxes are projected to lower tax revenue to 35.9 percent of GDP in 2005, partially compensated by strengthened collection of nontax revenue boosted by higher dividends from state-owned enterprises. Total revenue would decline by 0.8 percentage points to about 39.5 percent of GDP.

14. Expenditures will be reduced and rationalized. Virtually all non-interest current expenditure items will need to be rolled back as a share of GDP. At the same time, the budget will need to make room for larger interest obligations, and higher severance payments to support structural reform. Expenditure as a share of GDP is projected to decline to 40 percent.

  • Longer term fiscal sustainability will call for cuts in the public sector wage bill. By end-July 2005, government employment will be streamlined by 7 percent in the general government. The Law governing labor relations in public institutions will be amended by end-March 2005 to allow a 12-month severance package for the retrenched workers of the republican budget, to be paid out in two equal installments of CSD 5 billion (0.3 percent of GDP) each, in July 2005 and January 2006 (see paragraph 27 of the TMU). The law will also be amended to increase labor market mobility in the public sector and facilitate the dismissal of redundant workers. The employment cut will create some room within the total wage bill of CSD 79 billion excluding redundancy pay, to pay higher salaries to selected highly-trained government workers to retain their service and motivate performance. In addition, budgetary support for active labor market policies will increase in 2005 to facilitate re-employment of retrenched workers.

  • To achieve further decompression of the public sector wage ratio between skilled and unskilled workers and to keep the growth in the wage bill on a sustainable path, the government will agree on key elements of civil service reform by end-November. Building on the enactment of the Civil Service Law by end-March 2005 (structural benchmark) and with World Bank assistance, it will formulate a comprehensive plan by end-June 2005 to overhaul the civil service, as part of its overall strategy for public sector administration reform. This plan will cover the reform of the systematization procedure and provide an overall review of the staffing levels across the state administration.

  • To accelerate restructuring, subsidies will be cut by 0.5 percent of GDP in 2005, including in the railway company (ZTP), broadcasting (RTS), agriculture, and mining. However, subsidies for enterprise restructuring will be better targeted, and budget resources for the Transition Fund to cover restructuring in socially-owned and state-owned enterprises will sharply increase in 2005, with 1.2 billion dinars (0.1 percent of GDP earmarked for the latter—see paragraph 27 of the MEFP). To enforce compliance, subsidies will not be given to any entity that is not a registered taxpayer. Effective immediately, no payments from the Transition and Serbian Development Funds will be made to any enterprise that (i) has new arrears to the general government budget excluding penalties on pre-existing arrears starting from September 2004; (ii) raised its wage bill in the past 12 months by more than projected inflation; and (iii) failed to abide by its restructuring program.

  • Pending further reform of the social funds, transfers to the Employee Pension Fund, Farmer Pension Fund, and the Labor Market Fund will continue to enable them to make full benefit payments in 2005. Despite recent reform, the EPF remains in need of large financial support from the budget on an annual basis. Concurrently, the government will, with World Bank assistance, draw up a plan by end-March 2005 to address the structural problems of the EPF to ensure its medium-term viability. To address the financial plight of the Farmer Pension Fund, a comprehensive plan to deal with the FPF will be made by the same time. Given the tight budgetary situation, recently announced plans for the clearance of one-half month of EPF arrears in 2005 will be made conditional on the overall budgetary revenue performance and, if needed, will be delayed by one year. In any case, this payment will not be made before Q4 2005.

  • To increase efficiency in Union institutions, nominal transfers to the Union budget will remain broadly at their 2004 level. The ensuing adjustment of 0.4 percent of GDP will be supported by streamlining Union employment by about 15 percent—including through early retirement, voluntary redundancies, and natural attrition—in early 2005, and by other measures. To this end, (i) 2.0 billion dinars will be earmarked for redundancy payments (see paragraph 27 of the MEFP), and (ii) the Serbian and Montenegrin governments will amend the Law on the Yugoslav Army and the Law on Union-level Civil Employees to harmonize them with Republic-level legislation. The amendments will reduce the amount of redundancy payments from 24 to 12 months and the period of dismissal from 3 months to 30 days (submission to Federal parliament is a prior action and its enactment an end-December performance criterion). The Serbian and Montenegrin governments will work jointly on a strategy to reduce employment in the defense sector through early retirements and cuts in civilian employment. The Serbian and Montenegrin Ministries of Finance will monitor all off-budget military revenues and expenditures of the recently created Military Fund (MF) financed from the sales of military assets and rental income, which will be treated as budgetary spending under the program with the view of their eventual incorporation in the budget. For this purpose, all accounts of the MF will be brought into the Treasury Single Accounts by end-2004.

  • Transfers to local budgets (including for teachers in Vojvodina) will double to compensate for their loss of sales tax revenues after the introduction of the centralized VAT in 2005 (2 percent of GDP). The share of personal income tax revenue for local budgets will be increased from 30 percent of total collection in 2004 to 40 percent in 2005.

  • Expenditure on goods and services and other programs will be curtailed as a percent of GDP, while budget-financed capital spending (excluding military spending) will remain broadly constant as a share of GDP.

  • While the budget law includes an annual ceiling on contracting and guaranteeing public debt, a mechanism will be included in the public debt law to effectively monitor and control the granting of government guarantees and the disbursement of FLFPs to ensure that the desired fiscal policy stance is implemented.

15. The policies will be supported by reforms in tax administration. To ensure a smooth introduction of the VAT in January 2005, remaining outstanding enabling decrees for the VAT implementation were issued in October 2004. In addition, the government will request a follow-up VAT technical assistance mission to visit Belgrade in March 2005 to assess the initial VAT implementation and recommend early corrective measures, if needed. In line with international best practice, the selection criterion for large taxpayers will be changed to turnover by end-2004, rather than the current practice based on total revenues collected from 3 tax sources. Taxpayer services will be strengthened. By end-March-2005, taxpayer services for (a) tax law interpretation, (b) filling tax returns, and (c) tax liability information will be extended to all major tax offices country-wide in Belgrade, Novi Sad, Niš, and Kragujevac. Finally, to further enhance restructuring and improve financial discipline, the government will develop a plan to reduce enterprise arrears to the budget and social funds by end-November (structural benchmark).

16. Public expenditure management will benefit from Treasury reorganization and increase control over indirect budget users. As part of its reorganization, the Treasury will issue an action plan by March 2005 that will fully integrate the Public Payment Agency into the Treasury. With the Road Directorate brought into Treasury Single Account in August, all direct budget users are now fully covered by the TSA. Over the medium term, all accounts of indirect budget users will also be brought into the TSA. As a first step, the Treasury will draw up by June 2005 a full inventory of all indirect budget accounts denominated in dinars and foreign currency. To further strengthen public expenditure management, the government will by end-June 2005 submit a law requiring local governments to publish audited budget accounts.

17. Reform of the payroll system is a high priority. The MOF will implement a work program to pull together the present disaggregated payroll data bases and to move to a more centralized payroll processing that will allow fuller control over wage expenditures. To achieve these objectives, the MOF will undertake by end-March an audit of basic personnel records in budget institutions. In addition, it will review the Systematization Act for any vacant position that is not filled for more than a year and recommend their elimination. The MOF will strengthen its payroll division to allow it to initially construct and maintain a simple but reliable centralized database for all direct budget users. During 2005 this division will develop a program, jointly with the Budget Inspection Service, to carry out routine payroll management checks against the data base of key indirect budget users. By January 2006, the division will develop and introduce a standardized software package and complementary information system.


18. Fiscal adjustment continues in Montenegro. The 2004 general government deficit (before grants and foreign loan-financed projects, FLFPs) is targeted at €36.1 million, or 2.4 percent of Montenegrin GDP. In 2005, the fiscal deficit (before grants and FLFPs) will fall to €25.8 million, or 1.6 percent of Montenegrin GDP. Government approval and public announcement of the additional 2004 cuts and submission to the Parliament of the draft budget for 2005 in line with this MEFP will be prior actions for Board consideration of the fourth review. Over the medium term, the government is committed to continue lowering the deficit to ensure fiscal and external sustainability.

19. The government will maintain a predictable tax environment and protect the revenue base. Tax reforms will be implemented only in the context of annual budget laws or amended budgets, making revenue-reducing tax policy changes conditional on the availability of adequate revenues or offsetting measures to safeguard the deficit target. Such tax policy changes will not be considered if (i) actual recurrent budget revenues are below the budgeted levels, and/or (ii) the budget has accumulated new expenditure arrears during the year. The government will not extend the VAT rebate program based on retail receipts beyond November 2004. The second step of lowering PIT and social contribution rates that was originally envisaged on December 1, 2004 will only be followed by further reductions in PIT rates during 2005 and beyond if actual revenue performance exceeds projected levels by a sufficient margin to allow such cuts. The decision on further PIT rate reductions will be taken in close consultation with IMF and World Bank staff. There will not be further reductions in social contribution rates during 2005. The planned reduction in the Corporate Income Tax rate from 20 to 9 percent will only be effective from 2006. Finally, the government will refrain from extending new exemptions or differential VAT rates to any sector, and avoid restructuring tax debt in a manner that would undermine its tax collection over the medium term.

20. Fiscal adjustment will also be supported by prudent expenditure policies. To reduce the high share of non-discretionary expenditures, the government will cut budget-financed employment from its end-2003 level of 26,000 by 1,000 by end-2004, and by a further 800 in each quarter of 2005. Discretionary spending will be further reduced in 2005, with the amount of net lending and subsidies falling to 0.9 percent of Montenegrin GDP. The government will also avoid new privatization-related spending obligations (i.e., no subsidies or price guarantees will be provided to privatized companies, and no debt to third parties assumed unless already guaranteed by the government). The government will refrain from spending in the first half of 2005 the €7 million reserve it has set aside in the 2005 budget for the contingency that the December 2004 reductions in social contribution rates result in additional needs for transfers to the Pension and Health Funds. Finally, the government will cap the total amount of subsidy paid to Nikšic Steelworks under its privatization contract at €0.8 million in the draft 2005 budget and phase this subsidy out completely by end-2008.

21. The government will continue implementing a cautious strategy of domestic borrowing. Government net domestic financing (excluding FFCD repayment) will not exceed €12 million in 2004, and €10½ million in 2005. The government will continue developing the treasury bill market extending the maturity profile of its debt. The government will also continue increasing the share of treasury bills in total domestic financing, and will eliminate reliance on non-transparent loan agreements with individual banks and companies by end-2005.

D. Monetary and Exchange Rate Policies

22. The monetary program for the remainder of 2004 will continue tight credit policy to help contain domestic demand and inflationary pressures. For the year, end-period NFA are programmed to be broadly unchanged, while monthly average NDA will decline slightly from August, implying a 3.5 percent growth in reserve money during the last quarter. Dinar broad money and credit to the economy are projected to rise by 13.8 and 38½ percent during 2004, respectively. The NBS will stand ready to sterilize foreign exchange inflows to contain credit expansion.

23. The efficiency of money market operations will be strengthened. To increase its capacity to manage market liquidity, the NBS will expedite the implementation of repo operations. The government will submit to Parliament a draft law on the settlement of government liabilities to the NBS by end-November 2004, with a view to facilitating by end-2004 the restructuring of government debt held by the NBS into marketable bonds eligible for repo operations. In addition, to enhance public liquidity management and avoid implicit subsidies to banks, the remaining republican government and NBS deposits will be withdrawn from commercial banks by end-2004, except from one bank undergoing privatization. Meanwhile, by end-October 2004, the Ministry of Finance and the NBS will establish joint procedures for strengthening the coordination of fiscal and monetary policies, forecasting market liquidity and demand for T-bills and NBS-bills, determining the schedule for issuing these bills, and projecting government deposit flows.

24. Macroeconomic risks related to rapid credit expansion will be assessed. The NBS will prepare by end-March 2005 a detailed loan survey and a regular reporting standard, providing data on loans-and leasing contracts extended by Serbian bank-owned leasing companies-by industry, currency denomination, term-structure, and type of borrowers (including a breakdown of loans to households into consumer and mortgage lending), to monitor these risks. To increase transparency in the banking sector, the NBS will publish quarterly reports on banking industry trends starting with the report for end-2004.

25. The NBS will implement prudential measures to contain macroeconomic risks resulting from rapid credit growth. The rapid credit expansion, particularly the strong increase in credit to households, has contributed to an unsustainable rise in the current account deficit. Against this background, the following measures will be implemented:

  • The NBS will issue by end-December regulations requiring banks to assess and manage credit risk resulting from borrowers' exposure to exchange-rate risk, inter alia by determining borrowers' ability to service loans denominated in or indexed to foreign currency in the event of exchange rate changes.

  • The NBS and the government will support the recently established credit bureau in charge of monitoring individual's credit risk exposure and payment history in accordance with the EU Directives. By end-March 2005, the credit bureau's data base will be extended to comprise data on leasing activities, tax arrears and arrears to utilities, and lending to enterprises.

  • The NBS will issue by end-November 2004 a guideline to banks on consumer credits (excluding mortgage loans) that will recommend (i) limiting the monthly payment-to-net income ratio to 30 percent; and (ii) requiring a down payment of at least 20 percent of the purchase price of acquired goods. The NBS will also indicate to banks that stronger measures, including an increase in reserve requirements, will be considered if credit growth fails to slow down significantly. The NBS will inform Fund staff in writing by December 8, 2004 on the details of the banks' response as regards complying with the guideline.

  • To remove a bias in favor of foreign-sourced funding, by January 1, 2005 the NBS will broaden the reservable base by including (i) the stock of commercial banks' foreign borrowing of maturities of up to 4 years; and (ii) all new foreign borrowing by commercial banks independent of maturities.

  • To reduce prudential risks, the NBS will increase the capital adequacy ratio from 8 percent to 10 percent in March 2005.

  • The NBS will explore the modalities for starting to regulate and supervise leasing companies, and work with the government on drafting legislative changes to be discussed with Bank and Fund staff during the upcoming FSAP mission. Meanwhile, the NBS will assess the appropriateness of the current limit for connected lending between banks and leasing companies, while the Serbian government will assess by end-November 2004 the tax treatment of leasing contracts.

26. Exchange rate policy will continue to balance the objectives of reducing inflation and the external imbalance. Against the background of a large and growing current account deficit, exchange rate policy will be flexible and contribute to improving competitiveness, while at the same time strengthening confidence in the dinar. Exchange rate policy will be assessed frequently in light of current account, wage, and inflation developments.

E. Bank Reform and Financial Supervision

27. The NBS will substantially strengthen financial sector supervision. To this end, it will group all banks and insurance companies according to their respective risk assessment, with their supervisory plans clearly laid out by end November 2004, and cross-check banks' submitted reports against external audit reports by end-2004. An on-site assessment of the bank posing the largest potential systemic risk will be launched by end-2004, and the bank will adopt a time-bound plan by end-2004 to strengthen internal controls and governance. To send a clear signal that regulatory forbearance is ceasing, the NBS will further strengthen on-site and off-site supervision, and strictly enforce existing regulations. In particular, the NBS will withdraw the license of banks that do not meet the €10 million minimum capital requirement by end-2004, unless they are recapitalized by reputable investors with banking experience or meet the requirement through a merger (structural benchmark). The license of further banks—if any—failing to meet the minimum capital requirement will be withdrawn by end-March 2005. To improve financial sector transparency and market discipline, all banks, insurance and leasing companies will publish IAS compliant end-2004 financial results by end-June 2005. The NBS will also strictly enforce prudential requirements for insurance companies and require comprehensive year-end audits, with management letters provided to the NBS.

28. In Serbia, progress in bank privatization and resolution will continue and governance in BRA-controlled banks will be strengthened. Building on progress in privatizing Jubanka, the BRA will launch the privatization tender for Niška Banka by end-2004 (structural benchmark). Meanwhile, management in the two largest banks with state-majority holdings has been improved. For Vojvodanska Banka, the tender for a privatization advisor was issued on October 7, 2004 with a view to appointing the advisor by end-February 2005, and launching the tender for its privatization in the third quarter of 2005. Concurrently, with bilateral assistance, the BRA will further strengthen its reporting requirements, control mechanisms, and governance in other nationalized banks to preserve their value prior to resolution. After some delays due to legal procedure, the BRA will launch the sale of its residential mortgage loan book by end-2004 and initiate the sale the 25 largest corporate and commercial unimpaired (non-public, not on privatization list, not bankrupt) loans by end-March 2005. Meanwhile, Parliament will adopt new laws on Deposit Insurance, Bank Liquidation, and Bank Rehabilitation Agency by end-March 2005, after consultation with World Bank and IMF staff.

29. In Montenegro, banking supervision will remain vigilant and bank privatization and asset resolution will continue. The CBM has further strengthened banking supervision, in particular by further improving compliance with Basel core principles and strengthening the focus on risk management. Moreover, it has remained vigilant in light of rapid credit expansion, inter alia by ensuring that a moderate deterioration in the quality of banks' loan portfolio was appropriately accompanied by an increase in loan-loss provisioning. To further reduce state influence in the banking sector, the government will launch a tender for a privatization advisor for the largest state-owned bank by end-November and sign the contract with the advisor by end-2004. The privatization tender will be launched by end-April, 2005. The government and the CBM will also prepare a strategy by end-2004 to divest all state minority holdings from the banking system, and refrain from increasing this stake in the banking system in the meantime. The government will begin by end-2004 the sale of non-financial assets carved out from the banking sector, initiating by end-March 2005 the sale of at least 50 percent of the unimpaired assets, and by end-June 2005 all remaining unimpaired assets. To level the playing field for banks and improve Treasury cash management, all republican government deposits with commercial banks will be transferred to the single treasury account in the CBM by end-2004 (structural benchmark), with the exception that republican government deposits at Podgoricka Banka will decline by €2 million from their end-August level, and fall to zero by end-June 2005. Finally, enhanced balance sheets for the central bank and for deposit money banks will be available by end-2004 to improve the monitoring of banking and fiscal developments.

F. Enterprise Sector

30. Wage bills in state enterprises will continue to be controlled to contain inflation pressures and encourage restructuring. To help ensure that the state enterprise wage bill remains under control, the government will pass by end-November a decree requiring ex ante approval by the Ministries of Labor and Finance for wage increases in 8 public utilities. On this basis, the government agrees to treat the wage bill ceiling on the 7 monitored public utilities as a performance criterion from end-December 2004.4 The wage bill in the monitored state enterprises in 2005 will be allowed to grow by 7 percent on an average basis. To facilitate the necessary cost rationalization, detailed business plans, including new organization charts (sistematizacija) will be prepared by end-2004 for most monitored public utilities—including for NIS, EPS, and ZTP—clearly showing redundant workers. Redundancy payments for the laid-off workers will be covered from the non-wage budgets of the enterprises and from the Transition Fund in the budget (0.1 percent of GDP). In the event of spin-offs as a result of future restructuring, the monitored wage-bill envelope will be adjusted downward for the wage-bills of the spun-off units.

31. Accelerating the privatization and restructuring of socially-owned enterprises is critical for improving export performance and for rapid sustained growth. To this end, we will ensure that:

  • The Privatization Agency (PA) will offer for sale, through auctions, 135 companies between October 1 and December 31, 2004 and will sell at least 50 percent of these companies; and another 60 companies between January 1 and March 31, 2005, out of which at least 40 percent will be sold.

  • The PA will offer for sale 3 companies from the list of companies under restructuring through tenders or auctions, or parts thereof through asset sales between October 1 and December 31, 2004; and three more companies from the list between January 1 and March 31, 2005. The launch of tenders for 3 companies will be a prior action for the review.

  • The PA will complete the first Share Fund sale through a public offer compatible with the Securities Law by December 31, 2004, and submit to Parliament amendments to laws necessary to enable steady progress in Share Fund sales by end-March, 2005. On this basis, it will revive sales of residual state-owned shares in socially-owned enterprises either through public offers or through sales via the Stock Exchange. At least three more such transactions will be initiated by end-March 2005.

  • The government will also ensure progress in the remaining large privatization transactions, which will allow the launch of a tender for a privatization advisor for at least one of the following telecom privatization transactions by end-March 2005: (i) mobile telephone operations of Srbija Telekom; (ii) Mobtel; (iii) third mobile license (excluding Srbija Telekom, PTT, and Mobtel from participating as buyers). The government will ensure that all tenders are carried out transparently, in accordance with international best practice.

  • To ensure fiscal transparency, all privatization proceeds will be treated as budgetary financing (below the line) and spending will follow normal budgetary procedures.

32. To accelerate privatization, we envisage debt workouts for large socially-owned enterprises coordinated by a unit under the Deputy Prime Minister's supervision. The framework for such agreements will be strengthened through amendments to the Privatization Law by [end-2004], which will enshrine the principle of write off of enterprise debts to state creditors and public utilities, conditional upon privatization. To enable the privatization of highly indebted enterprises by reducing their debt without creating moral hazard, write-offs of tax and social contribution arrears, and of obligations to public utilities or state-owned banks will be conditional on actual sale or final bankruptcy, and most often involve a haircut for remaining creditors imposed by an inter-ministerial negotiating group. Private creditors may accept haircuts in return for prompt payment, or may be forced to do so by public sector creditors whenever—as is most often the case—public sector creditors account for the majority of claims.

33. An effective bankruptcy process provides a critical building block of the government's strategy for strengthening enterprises' financial discipline. The bankruptcy process will become fully operational by end-February 2005, following the adoption of bylaws to the Bankruptcy Law and the establishment of: (a) a Supervisory Body to license, supervise, and regulate bankruptcy trustees; (b) a specialized unit within the Privatization Agency to act as bankruptcy trustee for state- and socially-owned enterprises. As part of this process, an amendment to the Law on the Privatization Agency enabling the PA to act as the bankruptcy trustee agency for state- and socially-owned enterprises will be enacted by end-2004 (structural performance criterion). The government will complement rapid progress toward a functioning bankruptcy process by initiating bankruptcy procedures under the new regulations against three large, heavily indebted, and loss-making socially-owned conglomerates under restructuring programs by end-March 2005.

34. The Serbian government is firmly committed to improving the financial performance of the railway company (ZTP) by accelerating restructuring and downsizing employment. Delays in restructuring and excessive employment have created large losses and imposed a substantial budgetary burden through annual subsidies of ¾ percent of GDP. Against this background, the Ministry of Capital Investment will prepare by end-February 2005, in consultation with the Ministry of Finance and World Bank and Fund staff, a restructuring plan drawing on the Business Plan for 2004-2008 elaborated by the consulting company Booz-Allen-Hamilton. This restructuring plan will provide detailed timetables covering 2005 for (a) reducing labor redundancies; (b) spinning off all non-core activities of ZTP with a view to privatizing them; (c) potentially closing loss-making secondary railway lines, if the respective segments are not taken over by investors in the form of subconcession contracts; and (d) raising the price of passengers' tickets and freight tariffs early in the year. Moreover, the government will submit to parliament by end-March 2005 a transportation law agreed with the World Bank that provides for the unbundling of ZTP into separate transportation and infrastructure companies.

35. The Serbian government will continue restructuring public utilities based on strategic plans.

  • The government will create an operational regulatory framework with an independent regulatory body for natural monopolies by end-2004, and will prepare a modern law on royalties to be paid by companies involved in extracting natural resources, for which it will request World Bank assistance.

  • It will ensure that after its unbundling by end-February 2005 (performance criterion) into two separate companies, one for power generation, distribution and distribution system management, and one for transmission and dispatch, EPS will (i) complete the spin-off of all non-core activities; (ii) reduce its core employment by 7 percent (relative to end-September 2004), in line with the company's strategic plan; (iii) service all its debt to the government in full except for Kosovo-related debt; and (iv) not receive any budgetary subsidy in 2004-2005.

  • To enhance collection and strengthen enterprise budget constraints, public utilities will enforce penalties on late payments and cut off supplies to commercial users that are not honoring their payment obligations for more than two months. If the government considers that continuation of delivery to these enterprises is imperative for strategic or social reasons, the utility bills will be paid from the budget.

  • Finally, to raise transparency in the sector, all monitored public utilities will publish by end-June 2005 an auditor's report on their 2004 accounts in line with IAS prepared by a reputable international auditing firm engaging a review partner with relevant industry experience from outside the local office.

36. Privatization in Montenegro is proceeding. The Nikšic steel company has been privatized, hotels are being sold at a brisk pace, and the large aluminum company (KAP) is at an advanced stage in its privatization process. In addition, Montenegro Telecom is expected to be offered for sale in the first half of 2005. The republican budget's privatization proceeds have been conservatively budgeted at €6 million in both 2004 and 2005, but can be higher without affecting deficit targets (i.e., additional privatization receipts will be offset with equal reduction of net domestic financing). The government will refrain from granting electricity subsidies to privatized companies or extending any government guarantees.

G. Foreign Trade System

37. The foreign trade system is being harmonized internally and liberalized through regional agreements. Following an agreement on a timetable to harmonize the trade, customs, and indirect tax regimes of the two republics adopted in August 2003, tariff rates have been harmonized with the exception of tariff lines for 56 agriculture products and of special import levies and seasonal tariffs for a range of additional products. All export and import quotas have been eliminated. A Joint Customs office with competence on trade with EU countries has been set up. Even though the harmonization process—as requested by the EU—is not yet complete, the EU has signaled that it could adopt a more flexible approach towards the preparation of a feasibility study for the Stabilization and Association Agreement. Significant progress in the resolution of the outstanding issues with the European Commission relating to sugar trade has allowed the resumption of sugar exports to the EU. A trade agreement to liberalize trade in textiles with the EU is expected to be finalized by the end of the year. Discussions on bilateral Free Trade Agreements with neighboring countries within the initiative of Stability Pact-aimed at facilitating trade through harmonized rules and standards, and simplified customs procedures—have progressed well. Free Trade agreements with Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Moldova, and Romania have been ratified and implemented, while work is underway to review the trade agreement with Macedonia. Preparations for the WTO accession process are continuing, with the first meeting of the Serbia and Montenegro Task Force for WTO accession envisaged in 2005. Customs operations are expected to be further strengthened, including at the Union level. To avoid backtracking on reforms and maintain a competitive market environment, both member states will refrain from introducing or intensifying import restrictions. Serbia and Montenegro agree to improve the comparability of respective external sector data, and provide foreign debt data on a periodic basis.

III. Program Monitoring

38. Macroeconomic policy performance under the EA will continue to be monitored through quarterly quantitative performance criteria and indicative targets (Annex B). Progress in structural reform will be monitored through structural performance criteria and benchmarks on key policy measures (Annex D). Quarterly targets for 2004 remain as set in the Third Review documents except for a revision in the end-December ceiling on Montenegro's nonconcessional multilateral borrowing and an end-December performance criterion added for the wage bill of monitored state-owned enterprises in Serbia. Quarterly performance criteria are also proposed for end-March, 2005. Parliamentary approval of a revised 2004 budget for 2004 in Serbia and parliamentary submission of annual 2005 budgets for Serbia and for Montenegro in line with policies described in this memorandum, as well as issuing tenders for 3 socially-owned enterprises in Serbia, government approval and public announcement of the additional 2004 budget cuts in Montenegro, and submission to federal parliament of amendments to two laws governing union-level employment will constitute prior actions for Board consideration of the fourth review under the Extended Arrangement (Annex D).

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Technical Memorandum of Understanding

I. Introduction

1. This memorandum replaces the Technical Memorandum of Understanding attached to the Memorandum of Economic and Financial Policies of May 21, 2004. It sets out the understandings regarding the definitions of quantitative and structural performance criteria, benchmarks, and indicative targets for the program supported by the Fund under an Extended Arrangement (EA), as well as the related reporting requirements. The key changes in this updated memorandum include definitional changes in the external debt ceilings and data revisions.

2. To monitor developments under the program, the authorities will provide the data listed in each section below to the European Department of the Fund, in accordance with the indicated timing. The quantitative performance criteria and indicative targets will be monitored on the basis of the methodological classification of monetary and financial data that was in place on December 31, 2002, except as noted below. Quantitative performance criteria and indicative targets for end-December 2004, end-March, end-June, end-September and end-December 2005 are specified in Annex A of the Memorandum of Economic and Financial Policies (MEFP).

3. For program purposes, the public sector consists of the consolidated general government (comprising union operations, Serbian state and local governments, the Montenegrin state government, the Serbian and Montenegrin social security funds, and the Serbian and Montenegrin special budgetary programs), the National Bank of Serbia (NBS), and the Central Bank of Montenegro (CBM). The authorities will inform the Fund staff of any new funds or special extrabudgetary programs that may be created during the program period to carry out operations of a fiscal nature as defined in the IMF's 2001 Manual on Government Financial Statistics, and will ensure that these will be incorporated within the definition of consolidated general government.

II. Quantitative Criteria: Definitions and Reporting Standards

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

4. Definition. Net foreign assets (NFA) of the NBS consist of foreign reserve assets minus foreign reserve liabilities.

  • For purposes of the program, foreign reserve assets shall be defined as monetary gold, holdings of SDRs, the reserve position in the IMF, and NBS holdings of foreign exchange in convertible currencies. Any such assets shall only be included as foreign reserve assets if they are under the effective control of, and readily available to, the NBS. In particular, excluded from foreign reserve assets are: frozen assets of the Union of Serbia and Montenegro (SM), undivided assets of the former Socialist Federal Republic of Yugoslavia (SFRY), long-term assets, NBS claims on resident banks and nonbanks, as well as subsidiaries or branches of SM commercial banks located abroad, any assets in nonconvertible currencies, encumbered reserve assets (e.g., pledged as collateral for foreign loans or through forward contracts), and precious metals other than monetary gold. For program purposes, all euro and foreign currency-related assets will be evaluated at program exchange rates; for 2004, the program exchange rates are those that prevailed on December 31, 2003. In particular, US$1 = CSD 54.6372, €1 = CSD 68.3129, and SDR1 = US$ 1.4806. Monetary gold shall be valued at an accounting price of US$ 416.85 per ounce. On September 30, 2004, the NBS's foreign reserve assets as defined above amounted to US$3,622.4 million, including gold valued at US$140.4 million.

  • For purposes of the program, foreign reserve liabilities shall be defined as any foreign-currency-denominated short-term loan or deposit (with a maturity of up to and including one year); NBS liabilities to residents and nonresidents associated with swaps (including any portion of the NBS gold that is collateralized) and forward contracts; IMF purchases; and loans contracted by the NBS from international capital markets, banks or other financial institutions located abroad, and foreign governments, irrespective of their maturity. Undivided foreign exchange liabilities of SFRY are excluded. On September 30, 2004, the NBS's foreign reserve liabilities, as defined above, to nonresidents were US$1,086 million and to residents were US$954 million.

  • All assets and liabilities denominated in convertible currencies other than the U.S. dollar shall be converted at their respective exchange rates against the U.S. dollar prevailing on December 31, 2003. All changes in definition or in valuation of assets or liabilities, as well as details of operations concerning sales, purchases or swap operations with respect to gold shall be communicated to the Fund staff within one week of the operation.

5. Reporting. Data on foreign reserve assets and foreign reserve liabilities of the NBS shall be transmitted to the European Department of the Fund on a weekly basis within four business days of the end of each business week. To facilitate program monitoring, the NBS will provide the data at the indicated constant prices and exchange rates, as well as at current exchange rates. The NBS will report if any of the reported foreign reserve assets are illiquid, pledged, swapped, or encumbered.

6. Adjustors. For program purposes, net foreign assets will be adjusted upward pari passu to the extent that: (i) after September 30, 2004, the NBS has recovered frozen assets of the FRY, assets of the SFRY, long-term assets, and foreign-exchange-denominated claims on resident banks and nonbanks, as well as SM commercial banks abroad; and (ii) the restructuring of the banking sector by the Agency for Deposit Insurance, Rehabilitation, Bankruptcy, and Liquidation of Banks (BRA) involves a write-off of NBS foreign-exchange-denominated liabilities to resident banks. The net foreign assets floor will be adjusted downward by the shortfall relative to the programmed level of net external budgetary financing cumulative from December 31, 2003 (US$217.4 million through end-December 2004), and cumulative from December 31, 2004 (US$40 million through end-March 2005, US$40 million through end-June 2005, US$95 million through end-September 2005, and US$95 million through end-December 2005) with a maximum adjustment of US$100 million. The net foreign assets floor will also be adjusted by the amount that the end-September, 2004 outcome is revised.

B. Ceiling on Net Domestic Assets of the NBS

7. Definition. For purposes of the program, net domestic assets (NDA) of the NBS are defined as the difference between reserve money (as defined in section F) and net foreign assets (as defined in section A), with the latter being converted from U.S. dollars into dinars at the program exchange rates as specified above. The ceiling is established as the monthly average of each month with an end-month test date (i.e., the averages of December 2004, of March, June, September, and December 2005, respectively). The monthly average of NDA for program purposes will be calculated as the difference of the monthly average of reserve money and monthly average of NFA. The monthly average of NFA will be adjusted so that the disbursements of World Bank program loans and EU macro-financial assistance are counted as if they occurred on the first day of the month in which they were effected. As of September 30, 2004, NDA of the NBS so defined were valued at CSD -21,924 million (Annex B).

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

9. Reporting. The ceilings will be monitored on the basis of daily data on NBS foreign reserve assets and liabilities as defined under section A, and reserve money (as defined under section F), supplied to the European Department of the Fund by the NBS within four business days of the end of each business week. To facilitate program monitoring, the NBS will provide daily its foreign reserves liabilities, as well as the amounts and dates of World Bank and EU macro-financial assistance disbursements at the current and the program exchange rates.

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

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

  • For program purposes, net credit of the banking system to the consolidated general government is defined as all claims other than frozen foreign currency deposit (FFCD), bonds (i.e., credits, securities, and other claims in both dinar and foreign currencies) of the banking system on the consolidated general government less all deposits of the consolidated general government with the banking system, including foreign currency deposits. Foreign currency deposits and foreign-currency-denominated credits to the general government will be reported at the program exchange rates. Net bank credit to the consolidated general government in Montenegro will be monitored on the basis of data supplied by the Montenegrin authorities; at end-September 2004, net credit of the banking system in Montenegro to the consolidated general government in Montenegro amounted to €6.473 million (equivalent to CSD 442 million). At end-September 2004, net credit of the banking system to the consolidated general government so defined was CSD -18,368 million.

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

12. Adjustors. For program purposes, the ceilings on net credit of the banking system to the consolidated general governments will be adjusted downward by the cumulative increase in the stock of government debt held by the nonbank public (other than that related to the frozen foreign currency deposits), starting from January 1, 2003, and upward for any decrease. These performance criteria will be adjusted by the amount that the end-December 2003 outcome is revised. In addition, in the event of a shortfall in the sum of net foreign budgetary financing and privatization proceeds, the ceilings will be adjusted upward by 75 percent of the shortfall subject to the total adjustment limit of CSD 5 billion for Serbia's and €6 million for Montenegro's consolidated government. The ceilings will be adjusted downward for the excess of combined net external budgetary financing and privatization proceeds relative to budgeted levels that are not used (1) to reduce the government's external indebtedness by more than envisaged under the program, or (2) to cover investment and restructuring costs in consultation with the Fund in the context of reviews under the EA. Privatization receipts are defined to include all cash privatization receipts (defined as cash received by the government including the privatization agency), including those channeled to extrabudgetary funds, and from asset sales by the public sector and by state-owned or socially-owned enterprises. Net external budgetary financing is defined to include all budgetary (i.e., non-project) grants and loans, less amortization (on a cash basis). The estimation of the shortfalls (excesses) in the sum of net foreign budgetary financing and privatization receipts will be based on the following projections (cumulative from the beginning of the year specified) with the actual inflows evaluated at the average exchange rates of the month when funds are received:

Serbia (2004, in billions of dinars)


External Financing
Privatization proceeds

Serbia (2005, in billions of dinars)





External Financing
Privatization proceeds

Montenegro (2004, in € million)


External Financing
Privatization proceeds

Montenegro (2005, in € million)





External Financing
Privatization receipts

D. Nonbank Domestic Financing

13. Definition. Nonbank domestic financing to the consolidated general government is defined as any form of resident financing for the consolidated budget deficit other than (i) from the NBS, (ii) from commercial banks, and (iii) privatization proceeds. This will include domestic financing from nonbank financial institutions, nonfinancial enterprises, households, and all other domestic financing not elsewhere classified. Nonbank domestic financing covers any net change in the consolidated general government liabilities to any of these institutions, representing either direct loans or advances to the consolidated general government or holdings of securities of the consolidated general government, including promissory notes or other contractual obligations. FFCD payments are treated below the line as negative domestic nonbank financing.

14. Adjustor: if quarterly net nonbank domestic financing deviates from the projected quarterly cumulative path (coinciding with projected cumulative FFCD payments) provided below in billions of dinars, the excess (shortfall) will trigger an equal downward (upward) adjustment in (i) net banking system credit to the consolidated general government (performance criterion) and in (ii) net banking system credit to the consolidated general government in Serbia (indicative target).





Projected Nonbank Domestic Funding

E. Ceiling on Change in Domestic Arrears

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

16. Definition

  • For the purpose of establishing compliance with this indicative target, union-level expenditure is defined to comprise all budgetary activities specified in the Constitutional Charter, including the SM army and the SM pension fund for retired military personnel. The consolidated general government of Serbia is defined to comprise all budgetary institutions financed from the Serbian state budget, the Republican Pension and Invalidity Insurance Fund for Employees, the Republican Pension and Invalidity Insurance Fund for Self-employed, the Republican Pension and Invalidity Insurance Fund for Agricultural Workers, the Republican Health Insurance Fund, the Republican Labor Market Agency, all republican special directorates, and all other budgetary and extrabudgetary funds created by the government of Serbia existing before or created during the period of the program. The consolidated general government of Montenegro is defined to comprise all budgetary institutions financed from the state budget, the Republican Pension and Invalidity Insurance Fund, the Republican Health Insurance Fund, the Republican Labor Market Fund, and all other budgetary and extrabudgetary funds created by the government of Montenegro existing before or created during the period of the program.

  • The outstanding stock of domestic arrears comprises wage and pension arrears; arrears with respect to accrued tax and social security contribution obligations, including personal income tax and social security contributions of employees withheld at source; arrears on social entitlement benefits (apart from pensions) to households; arrears incurred with respect to the purchases of goods and services from suppliers; arrears related to the servicing of domestic debt and nonpayment of budgeted transfers to finance union-level expenditures.

  • The outstanding stock of wage arrears at a particular date are defined as total accumulated unpaid wages of all employees on the regular payroll of all units belonging to the parts of the general government as defined above, up to the latest preceding regular pay date, which have not been settled by the test date. The total stocks of wage arrears, thus defined, are on a gross basis and are calculated by summing the wage arrears of all units of government with regard to their own employees; transfers between different levels of government for making wage or other payments are excluded from the estimates of these wage arrears.

  • Pension arrears are defined as total accumulated pensions due but not disbursed by the pension funds concerned to all pensioners in the pension rolls up to the latest preceding pension disbursement date.

  • The outstanding stocks of tax and social contribution arrears at a particular date comprise total accumulated accrued tax obligations of the parts of the general government as defined above that have not been paid by the test date. The total stocks of such arrears are on a gross basis.

  • Social entitlement payments, apart from pensions, are defined as all cash payments due directly to, or on behalf of, the population in accordance with stipulations in the law and which are not contingent upon the provision of any services or sale of any goods or assets to the general government by such members of the population in return for these payments. The stock of such entitlement arrears are defined as total accumulated payments due but not disbursed by all units of government up to the test date. Thus defined, these arrears are also on a gross basis and do not include the netting out of any transfers made between different units of the general government for the payment of such entitlements.

  • Arrears to suppliers comprise payments delayed beyond what was explicitly specified in relevant contracts, or in the absence of such specification, for two months from the date of submission of bills, for already-effected purchases of goods or services by the government concerned. These include, inter alia, arrears to utility companies, arrears incurred with respect to service and maintenance contracts, and payments for capital goods. These arrears are also defined on a gross basis. Thus, overdue tax and other obligations to the government of relevant enterprises are not included in the calculation of the arrears of the government, and netting out of any transfers made between different units of the general government for the payment of such arrears and obligations are also not taken into consideration.

  • Arrears to domestic banks and nonbank lenders comprise all overdue payments related to financial contracts between the government and domestic banks, nonbanks, and private lenders.

  • € denominated claims on government will be converted at the program exchange rate; claims denominated in currencies other than the € will first be converted at their respective program exchange rates against the € . The change in arrears is defined as the change in the end-period stock of arrears. Changes in wage and pension arrears will be adjusted for the changes in the average wage and average pension in the economy relative to their respective values in September 2004.

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

F. Definition of Reserve Money

18. Definition. Reserve money is defined as the sum of currency in circulation (NBY Bulletin, September 2000, Table 3A, column 8) and dinar reserves banks are required to hold at the NBS, plus excess reserves of the commercial banks. Shortfalls in reserves that banks are required to hold will be included in required reserves (and therefore in reserve money), as well as in bank borrowing from the NBS. As of September 30, 2004, the required reserve ratio was at 21 percent of the base as defined in NBS Decision of March 28, 2002. Subsequent changes in the reserve requirement will be reflected in program definitions. The amounts that banks are permitted to hold in securities to satisfy the statutory reserve requirement will be limited to the amount that banks were holding as of December 31, 2000 (CSD 174.1 million). Excess reserves include commercial banks' (1) balances in Giro accounts 620, 621, 623, and 625; (2) overnight deposit in account 205 at the NBS; (3) excess balances above required reserves on account 201 at the NBS (with the shortfall in required reserves counted as negative excess); and (4) cash in vaults.

19. Data on reserve money will be monitored from the daily monetary indicators of the NBS, which will be supplied to the European Department of the Fund weekly by the NBS with a three-day lag. The end-month data is based on the NBS balance sheet, which will be provided to the Fund with a lag of less than three weeks. On September 30, 2004, currency in circulation amounted to CSD 42,463 million, while required reserves amounted to CSD18,738 million, and excess reserves to CSD 2,934 million. For program and projection purposes, monthly averages of reserve money and its components were used. Data on effective reserve requirements and the deposit base used in reserve requirement calculations will be supplied to the European Department on a ten-day basis with a lag of less than a week.

20. Adjustors. For program monitoring purposes, reserve money will be adjusted as follows. Should the standard reserve requirement increase (decrease) from the level prevailing on September 30, 2004, the ceiling on net domestic assets would be increased (decreased) by an amount equivalent to the change in the standard reserve requirement ratio multiplied by the programmed deposit base used in the calculation of required reserves. Before making any changes to the reserve requirement, the NBS will consult with Fund staff. Required reserves of banks placed under BRA administration or liquidation will remain part of reserve money for program purposes. Similarly, the CBM will consult with Fund staff before making any changes to the reserve requirement.

G. Ceiling on External Debt-Service Arrears

21. Definition. External debt-service arrears are defined as overdue debt service arising in respect of obligations incurred directly or guaranteed by the public sector, except on debt subject to rescheduling or restructuring. The program requires that no new external arrears be accumulated at any time under the arrangement on public sector or public sector-guaranteed debts.

22. Reporting. The accounting of nonreschedulable external arrears by creditor (if any), with detailed explanations, will be transmitted on a monthly basis, within two weeks of the end of each month. This accounting will include, separately, arrears owed at the union level, by the Serbian and Montenegrin governments, and other public sector entities; arrears owed by Yugoslav Airlines; and arrears owed to Paris Club creditors, London Club creditors, and other creditors. Data on other arrears, which are reschedulable, will be provided separately.

H. Ceilings on External Debt

23. Definitions. The ceiling on contracting or guaranteeing of new nonconcessional external debt by the public sector with original maturity of more than one year applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 (Decision No. 12274-(00/85), see attachment to this Annex) but also to commitments contracted or guaranteed for which value has not been received. Excluded from this performance criterion are loans from, or other indebtedness to, the EBRD, the EIB and EU, the IBRD, the IMF, and the IFC. However, in 2004 cumulative from December 31, 2003, contracting or guaranteeing by the public sector of new nonconcessional external debt from the EBRD, the EIB and EU, the IBRD, and the IFC will not exceed US$500 million by end-June 2004, US$500 million by end-September 2004, and US$500 million by end-December 2004 (Annex A defines the separate ceilings applicable for Serbia and for Montenegro). In 2005 cumulative from December 31, 2004, contracting or guaranteeing by the public sector of new nonconcessional external debt from the EBRD, the EIB and EU, the IBRD, and the IFC will not exceed US$100 million by end-March 2005, US$200 million by end-June 2005, US$300 million by end-September 2005, and US$400 million by end-December 2005 (Annex A defines the separate ceilings applicable for Serbia and for Montenegro).Contracting or guaranteeing of new debt will be converted into US$ for program purposes at the cross exchange rates implied by the official NBS exchange rates in effect on the day of the transaction. Concessionality will be based on a currency-specific discount rate based on the ten-year average of the OECD's commercial interest reference rate (CIRR) for loans or leases with maturities greater than 15 years and on the six-month average CIRR for loans and leases maturing in less than 15 years. Under this definition of concessionality, only debt with a grant element equivalent to 35 percent or more will be excluded from the debt limit. Second, with regard to the ceiling on new external debt with original maturity of up to and including one year owed by the consolidated general government or guaranteed by the public sector, the term "debt" has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 (Decision No. 12274-(00/85). Excluded from this performance criterion are normal short-term import credits.

24. Reporting. A debt-by-debt accounting of all new concessional and nonconcessional debt contracted or guaranteed by the public sector, including the original debt documentation, details on debt service obligations, as well as all relevant supporting materials, will be transmitted on a quarterly basis, separately by Serbia and Montenegro, within four weeks of the end of each quarter.

I. Ceiling on the Wage Bill of Serbian Public Enterprises

25. Definition. For December 2004, the performance criterion is set on the total annual wage bill of seven large public enterprises: JP Elektroprivreda Srbije, JP Naftna Industrija Srbije, JP Zeleznicko Transportno Preduzece Srbije, JP PTT Srbije, JP Srbija Sume, JP JAT Airways, and JP Telekom Srbija. For 2005, the performance criterion is set on a quarterly basis on the cumulative monthly wage bill of eight large public enterprises (the same seven enterprises as in 2004 plus JP Aerodrom Beograd). Wages are accounted on an accrual basis, excluding taxes and social security contributions, and include overtime payments and bonuses. Ceilings for end-December 2004 and for end-March 2005 are performance criteria set in the Fourth Review.

26. Adjustors. In the case of spin-offs of activities from these companies (defined as the spinning off of a unit or its transfer to another entity or temporary/permanent transfers of employees) after end-September 2004, the wage bill target will be adjusted downwards for the wage bills of spun-off units. In the case of EPS, the successor companies (according to MEFP paragraph 35, bullet two) will all be included in the wage ceiling.

27. Reporting. The wage bills of the eight monitored state-owned companies will be reported monthly to the European Department of the Fund and the Office of the IMF Resident Representative by the Ministry of Finance (Public Utility Restructuring Unit) with a lag of less than four weeks. Monthly data for JP Aerodrom Beograd will also be provided for the period January through December 2004.

Serbia (In CSD millions)






Wage Bill ceiling

J. Adjustor for Lower-Than-Targeted Severance Payments

28. Within the overall expenditure envelope of the 2005 budgets for the central government in Serbia, the Union level government, and the Serbian Transition Fund a total amount of CSD 8.2 billion is envisaged for severance payments, out of which (a) CSD 5.0 billion related to employment reduction in the Serbian central government; (b) CSD 2.0 billion related to employment reduction on the Union level; and (c) CSD 1.2 billion included in the funds for the Transition Fund related to employment reduction in the eight monitored state-owned enterprises listed in paragraph 24 of the TMU. While the expenditures under (a) and (b) will be financed through general budgetary revenue, expenditures under (c) will financed through privatization receipts. To ensure that these budgetary resources can be spent only for the intended severance payments, the ceiling on net credit of the banking system to the consolidated general government (performance criterion) and on net credit of the banking system to the Serbian consolidated general government (indicative target) will be adjusted downwards for the total shortfall of the respective severance expenditures in categories (a), (b), and (c).

Serbia: Projected Cumulative Path of Redundancy Payments in 200
in billions of dinars




Category a
Category b
Category b


III. Other Reporting Requirements for Program Monitoring

A. Macroeconomic Monitoring Committee

29. A macroeconomic monitoring committee, composed of senior officials from the Union Government, Serbian and Montenegrin Ministries of Finance, the NBS, CBM, and other relevant agencies, shall be responsible for monitoring the performance of the program, informing the Fund regularly about the progress of the program, and transmitting the supporting materials necessary for the evaluation of performance criteria and benchmarks.

B. Developments on Structural Performance Criteria and Benchmarks

30. The authorities will notify the European Department of the Fund of developments on structural performance criteria and benchmarks as soon as they occur. The authorities will provide the documentation, according to the dates in Annex C, elaborating on policy implementation. The authorities will also notify the European Department of the Fund expeditiously of any economic developments or policy measures (prior to taking such measures in the latter case) that could have a significant impact on the implementation of this program.

C. Data Reporting

Production and prices

31. Any revision to relevant macroeconomic data will be transmitted within three weeks of the date of the revision.

Public finance

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

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

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

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

  • Montenegro will report quarterly arrears data starting from end-December 2003 for the consolidated general government in Montenegro, separating out normal float, and providing end-quarter stocks of arrears and gross repayments of outstanding arrears during each quarter.

Monetary sector data

33. The following data will be transmitted on a daily/weekly/biweekly basis within one/five working days of the end of each day/week.

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

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

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

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

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

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

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

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

34. The balance sheet of the NBS and the consolidated balance sheets of Serbian commercial banks, as well as the balance sheet of the Central Bank of Montenegro and the consolidated balance sheets of commercial banks in Montenegro, will be transmitted on a monthly basis within three weeks after the end of each month. The stocks of government and NBS securities held by banks and by nonbanks, as available to the NBS, detailed information on interbank money market transactions (terms, duration, and participating institutions), and interest rate developments will be transmitted on a monthly basis within two weeks after the end of each month. Credit to government by the banking system is provided with detailed breakdowns on the union, state, and local governments.

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

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

  • Data on foreign borrowing by commercial banks with a breakdown according to maturities.

  • Individuals' foreign exchange savings in top ten banks.

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

External data

36. The data below will be transmitted as follows:

  • The interbank market exchange rate, as the simple average of the daily-weighted average buying and selling rates, will be transmitted on a weekly basis within five business days of the end of the week;

  • Balance of payments data on services, private transfers, and capital account transactions will be transmitted on a quarterly basis within four weeks of the end of each quarter;

  • Detailed monthly data on the volume and prices of exports and imports, separating out imported petroleum products; and

  • External debt data and debt service schedules separately for Serbia and for Montenegro, with breakdown by creditor.

  • The CBM will provide quarterly updates of the Montenegro balance of payments, including projections for the current and subsequent year, while the Montenegro Ministry of Finance will provide the external debt and debt service information described above.


1Annex A, attached to this memorandum, contains the quantitative performance criteria and indicative targets, while Annexes B and C list the structural performance criteria and benchmarks as well as prior actions. Annex D (Technical Memorandum of Understanding, TMU) defines the performance criteria and indicative targets and describes the reporting arrangements.
2In terms of Serbian GDP, the consolidated Serbian fiscal deficit is projected to decline from 3.2 percent of GDP in 2003 to 1.9 percent of GDP in 2004 (from 2.7 percent to 1.3 percent excluding FLFPs).
3In terms of Serbian GDP, the overall deficit will be cut by 1.3 percent of GDP in 2005 to 0.6 percent of GDP in 2005 (a surplus of 0.1 percent excluding FLFPs).
4The number of monitored enterprises increases to 8 from January 1, 2005 (see paragraph 24 of the TMU).