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

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Sofia, Bulgaria, August 20, 1999

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Camdessus:

Economic developments in Bulgaria continue to be broadly favorable, with sustained macroeconomic stability. However, exports have declined, reflecting the ongoing process of restructuring and adverse external circumstances, including the effects of the Kosovo crisis. As a result, we expect lower growth in 1999 than originally envisaged, although the sound foundations for sustained medium-term growth have been laid.

Against this background, the Government of Bulgaria has adopted policies that are expected to safeguard the medium-term objectives of our three-year program of macroeconomic and structural adjustment supported by the extended arrangement. The attached Memorandum of Economic Policies of the Government of Bulgaria updates and revises the memoranda of September 9, 1998 and January 29, 1999 and the Letter of Intent of May 28, 1999, and describes policies for the second program year that started on July 1, 1999. We regret to inform you that we have not observed the end-June 1999 performance criterion on tax arrears, but note that this in large part reflects a postponement of the use of the budget's structural contingency funds in a manner that reduces tax arrears from the second quarter to the third quarter of 1999. Moreover, corrective policies have already been undertaken to ensure this criterion will be observed in future: the Government of Bulgaria is pushing ahead with vigorous reforms in the areas of structural adjustment, privatization, and the imposition of hard budget constraints on state-owned enterprises. On the basis of performance under the arrangement thus far and the policies described in this letter, we request the completion of the second review under the arrangement and a waiver of nonobservance for the end-June 1999 performance criterion on tax arrears.

The Government of Bulgaria believes that the policies and measures described in the attached Memorandum are adequate to achieve the modified objectives of its economic program, but it stands ready to take any additional measures as necessary to keep the program on track. The government will remain in close consultation with the IMF in accordance with the IMF's policies on such consultations.

Sincerely yours,

Muravei Radev
Minister of Finance
Svetoslav Gavriiski
Governor, Bulgarian National Bank

Attachment: Memorandum on Economic Policies of the Government of Bulgaria



A.  Introduction

1.  In 1999, our stabilization and reform program to establish a competitive and predominantly private market economy has continued to be successful in many areas. Inflation has been remarkably tame, with consumer prices actually falling by 3 percent over the 12 months to June 1999. Fiscal performance has remained strong, as the general government registered an overall surplus of 10 million leva (0.1 percent of GDP) in the first half of the year.1 Incomes policy has been implemented strictly, with the total wage bill of the loss-making state-owned enterprises falling in the first half of this year. Privatization and restructuring have advanced, banking supervision and regulation have improved, and land restitution and titling have progressed further. Confidence in the lev has remained strong, and gross official reserves (at US$2.7 billion, equivalent to over 6 months of imports of goods and nonfactor services, at end-June) remain comfortable. Also, the fiscal reserve account (FRA) continues to have ample resources (US$1.2 billion at end-June), providing a sound basis for the currency board arrangement (CBA) to which we remain fully committed.

2.  However, recent adverse external developments and transition strains have weakened near-term growth prospects and the external current account. The turmoil in global markets reduced Bulgaria's partner country demand and export prices already in the second half of 1998, and this adverse external environment has continued this year. In addition, in 1999 the Kosovo conflict has inflicted further damage to exports and investor confidence. These external shocks have coincided with a difficult phase of our economy's transition, as many state-owned enterprises in the traditional export industries are being privatized, restructured, or entered into liquidation. As a result, there has been little output growth so far in 1999, and the external current account deficit during the first four months of the year amounted to US$320 million (8 percent of GDP), compared with US$27 million during the corresponding period last year.

3.  Nevertheless, we are firmly committed to maintaining macroeconomic stability and advancing structural reform. To this end, we will continue to conduct economic policies in the framework of the three-year program (July 1998-June 2001) which the IMF supports under the extended arrangement. The remainder of this memorandum details the macroeconomic and structural objectives and policies for the period ahead.

B.  Macroeconomic Objectives and Policy Framework

4.  While we believe that our medium-term goals, including annual GDP growth of 4-5 percent, remain achievable, we have modified the objectives for 1999 (see tabulation below). Specifically, we have scaled down our projection for output growth for this year, but we believe that our policies together with an improved external environment will help strong growth to resume in 2000. By then, inflation is expected to rise from the current exceptionally low level while still remaining moderate. Regarding the balance of payments, we aim at limiting the current account deficit to about 5 percent of GDP this year, with a significant decline in the deficit targeted for 2000. Given the uncertain external situation, we will aim to keep reserve cover at about 7 months of imports during both years, with the FRA increasing to well above the end-1998 level.

  Actual   1st Review Proj.   Proj.

GDP growth (real; in percent) 3.5   3.7 1.5   4.0
CPI inflation (end of period; in
1.0   6.3 1.8   2.8
Gross official reserves
   (end of period; in billions of US$)
   (end of period; in months of imports)
External current account deficit (in
   percent of GDP)
2.1   3.1 5.6   4.1
Fiscal reserve account (end of
   period; in billions of US$)
1.1   1.4 1.4   1.5

5.  To achieve these objectives, we will continue our prudent fiscal and incomes policies and intensify the structural reform process. An appropriately tight fiscal policy and strict limits on wages in state-owned enterprises will underpin the CBA and protect competitiveness, and structural reform will foster private sector initiative and investment to create sustained rapid growth. The priorities in the structural area will include completing the privatization program, restructuring the large monopolies (especially in the energy sector), continuing reforms in the financial, agricultural, and trade sectors, and improving labor market flexibility (Tables 1 and 2). With these measures, we expect that we will receive adequate support from the international community to make the achievement of our ambitious goals feasible.

C.  Fiscal Policy

6.  To underpin the CBA and limit the deterioration of the external current account balance, we will contain the 1999 general government deficit to 1.5 percent of GDP, while the primary surplus should be well over 3 percent of GDP. We are confident that these objectives are within reach as strong revenue performance and expenditure restraint resulted in a small overall surplus in the first half of the year. In fact, achievement of the tightened deficit target will involve a cautious relaxation of the fiscal stance during the remainder of the year. As we expect revenue performance to remain strong, this relaxation will entail increased spending from the low levels in the first half of the year: budgetary wages were raised by 7.5 percent as scheduled from July 1 (though some savings relative to the original budget will be achieved by limiting the 13th month wage to workers in the education sector and by reducing staffing by more than the targeted 4 percent); expenditure on maintenance and operations will be restored toward budgeted levels; defense spending has been raised to meet the needs related to the Kosovo crisis; and spending on investment is being expanded to accelerate the program of infrastructure development, thereby strengthening the foundation for future growth. To ensure that the targeted deficit is not exceeded, we will continue to utilize the provision under the Annual Budget Law that allows the Ministry of Finance to limit discretionary expenditures to 90 percent of the budgetary allocation, and we will continue to save any windfalls relative to the program in interest payments on external debt. As for the transitional costs of structural reform, for which the budget had allocated 240 million leva (1 percent of GDP), so far some 24 million leva has been used. During the remainder of the year, we will continue to use these funds only for one-time operations that ensure a final resolution for enterprises to be privatized or liquidated.

7.  On the revenue side, we will continue to improve tax administration to help maintain and bolster revenue performance. To this end, we have submitted to parliament a draft Tax Procedure Code which we expect parliament to adopt by end-September 1999. The Code expands the enforcement powers of tax officials, improves filing and payment procedures, strengthens audit methods, and provides for the full implementation of the Bulstat identification number as a single identifier for taxpayers. The Code also limits the collection responsibilities of the General Tax Administration Department (GTAD) to national and local taxes so that the GTAD will no longer be involved in the collection of vehicle licenses, court fees, and other similar levies. Moreover, we will work on improving coordination among revenue collection agencies by producing a first-round unified tax register based on the Bulstat number by end-1999, and by setting up an automatic file-matching system among GTAD, the National Social Security Institute (NSSI) and the General Customs Department by end-March 2000. Building on the success of the VAT so far, we have resisted pressures to provide exemptions for selected sectors, and will grant no new tax exemptions during the EFF program period. Legislation to remove one of the few remaining VAT exemptions, that on tourist services provided abroad, will be prepared in the context of the 2000 budget, to be effective from January 1, 2001. To ensure reimbursement of valid VAT refund claims on a timely basis while protecting government revenue, we will by end-1999 implement a selective audit program to control fraud instead of relying on a full audit of each and every taxpayer. To guard against the possibility of a sharp increase in pending VAT refund claims, we will shortly set up a mechanism to monitor on a monthly basis the stock of claims made and processed. Similarly, we will ensure that the recently introduced duty drawback scheme functions smoothly, without a build-up of liabilities. Finally, by end-1999 we will create separate tax policy and tax administration departments to ensure an efficient division of labor between tax administration and the formulation of tax policy and legislation.

8.  The good revenue performance has been achieved despite some further increase in tax arrears. The arrears in monitored enterprises increased from 457 million leva at end-March to 560 million leva at end-June 1999, indicating that we missed the performance criterion on tax arrears by a margin of 55 million leva. In part, the nonobservance of this criterion results from our inability to use the bulk of the structural contingency funds designed to promote privatization and enterprise restructuring before the second half of the year. We had anticipated that these funds could be used in the second quarter in a manner that would reduce tax arrears by 70 million leva, but this proved infeasible. To help set tax arrears on a sharply declining trend starting in the third quarter of 1999, we are strengthening tax administration, as described in the previous paragraph. We realize, however, that given the concentration of overdue obligations in large state-owned enterprises (especially Bulgargaz, Neftochim, and BDZ) the tax arrears problem goes well beyond tax administration. Accordingly, we are taking decisive action to privatize Neftochim and restructure Bulgargaz and BDZ (see paragraphs 18 and 21-23 below), and we expect that the privatization and restructuring of these and other state-owned enterprises will be the main vehicle for reducing tax arrears in future. To improve the monitoring of the degree to which hard budget constraints are in place, we propose widening the scope of the performance criterion on tax arrears in monitored enterprises to include interest and penalty charges. With the decisive structural measures implemented so far and envisaged for the remainder of the year, we are committed to reducing these obligations from the end-June 1999 level of 759 million leva by 415 million leva by end-September, 1999, and by a further 20 million leva in the last quarter of 1999. We will also closely monitor overdue obligations to customs and social security by the 30 companies with the largest arrears in these areas, which now amount to 150 million leva, and are committed to reducing the sum of these arrears (including interest and penalty) by 65 million leva during the second half of the year. From the beginning of 2000, we are prepared to include customs and social security arrears in the performance criterion on tax arrears.

9.  We will continue to focus on improving control over budgetary spending, primarily through further steps toward a well-functioning treasury system. Major progress has already been achieved: most of the over 1,000 extrabudgetary funds and accounts were eliminated from January 1, 1999, the number of first level spending units was sharply reduced, and a consolidation of all budgetary financial resources is underway. Building on this progress, we will consolidate most central government extrabudgetary accounts and funds into the general government budget, and include them in the single treasury account from January 1, 2000. From this date, the single treasury account will also absorb all remaining accounts of the central republican budget in commercial banks. We will coordinate the transition toward the single treasury account with the Bulgarian National Bank to avoid disturbances in bank liquidity in the process. We will reduce the number of second level spending units next year substantially from the present over 2000, and examine the scope for further reducing the number of first level spending units. We will amend the government chart of accounts to allow the implementation of the 2000 budget on this new basis, adopt new reporting requirements, and put in place an improved financial management information system. Building on progress in this area, we will improve internal audit and put in place a strengthened budgetary procurement process. Finally, to improve the payment system, we will switch to electronic payments of budgetary transactions by mid-2000.

10.  Improvements in budget management practices should have a salutary effect on fiscal transparency. By end-September 1999, we will review the regulatory framework to allow compensation to banks for payments services provided to the government, and by end-1999 we will establish framework agreements with commercial banks for handling government payments through zero-balance accounts. To facilitate the flow of information to the general public, we will further improve the reports and analyses of the budget made available to the public.

11.  We will continue reforms in the social security system. As for the pension system, we recognize the need to achieve a financially sustainable three-pillar system with both private and public sector participation. Three changes in the legal framework (requiring employers to pay pension contributions for periods of illness and maternity leave, making fringe benefits subject to social security contributions, and raising the minimum contribution base for the self-employed) from January 1, 1999 alleviated the most burning issues of the existing pay-as-you-go pension system. Despite these changes, adverse demographic trends, widespread evasion of social security contributions, and overly generous pension formulae continue to keep the system on an unsustainable path, and urgent reform is needed. To this end, we will sharply reduce eligibility for early retirement, gradually raise and bring closer together the minimum retirement age for men and women, harmonize the contribution rates paid by employees and the self-employed, and introduce a closer link between benefits and lifetime contributions. The legal framework for private participation has been created by the Voluntary Pension Insurance Law, adopted by parliament in July 1999. We will finalize the parameters of pension reform by end-August, with a view to ensuring the medium-term sustainability of the system while allowing for initial transitional costs to be borne by the 2000 budget. Finally, we will launch a public education campaign by end-September to prepare the ground for this crucial reform and enhance the prospects for its success. Turning to the health sector, during the second half of 1999 we will take decisive action to address the shortcomings of the health insurance fund contribution (HIFC) system. We will prepare draft amendments to the Health Insurance Act to harmonize the definitions related to the revenue base of the HIFC with those of the pension and unemployment contributions, and ensure that the NSSI has appropriate administrative powers to collect the HIFC. We will submit the necessary draft amendments to parliament by end-September with a view to having them adopted by end-1999. We will also focus on finding cost-effective ways to use the existing resources to deliver health services, in particular through eliminating overcapacity and overlap in service delivery. To improve the collection of social security contributions, by end-October 1999 we will submit to parliament a draft Social Security Code consistent with the Tax Procedures Code to underpin the NSSI's legal and regulatory framework from January 1, 2000. This Code will provide to NSSI the full range of collection enforcement powers, including pursuit of third-party debts, sequestration of bank accounts, and seizure of property.

12.  We have determined the key parameters and priorities of the draft 2000 budget in line with our medium-term fiscal strategy. This strategy envisages maintaining the underlying general government position in approximate balance while allowing for one-time costs of structural reform. Details of the draft 2000 budget will be discussed with IMF staff in October before it is submitted to parliament, and approval of an agreed 2000 budget will be a condition for completing the third program review. Consistent with our macroeconomic framework, the draft 2000 budget will maintain the general government deficit at
1-1 percent of GDP, with a broadly balanced underlying position and an allocation of up to 1 percent of GDP to help cover the transitional costs of structural reform. The latter will comprise budgetary financing toward the initial deficits of the new pension and health systems and, as in 1999, funds to promote enterprise privatization and restructuring. The primary surplus will be targeted at around 3 percent of GDP. In determining the allocation of expenditures, we have decided to adopt a top-down approach to avoid inefficiencies stemming from fragmented decision making and to help prioritize the spending needs. Thus, we have prepared a preliminary allocation of non-interest expenditure for 2000 in nine main functional areas, and will ensure that any reallocation is done within the constraint imposed by the overall deficit target for general government. We believe that this approach will help keep fiscal policy appropriately flexible and supportive of the currency board arrangement. Detailed decisions on expenditure allocations are yet to be made, but we intend to keep the wage bill in the budgetary sector broadly at the 1999 level as percent of GDP, and to maintain the real value of social assistance while improving its targeting to make it possible to provide the truly needy with more than symbolic support. As for revenue, the aim is to keep at least at this year's projected level of 38 percent of GDP. We will limit tax policy measures to those reducing the presently high burden of tax and social contributions on labor and unifying corporate profit tax rates, to the extent these can be accommodated within the overall revenue target. Our primary focus in developing the revenue side of the budget for 2000 will be on strengthening tax administration. In particular, we will (i) further increase NSSI and GTAD cooperation on collection enforcement and audit activities; (ii) further simplify taxation of small businesses; (iii) pass draft amendments to laws to harmonize the main elements of revenue bases for the personal income tax and social security and health insurance contributions, especially with respect to the self-employed and small businesses; (iv) define work relationships to have an employment character when they satisfy criteria that are prescribed in the laws or regulations; and (v) continue to prohibit the offsetting of tax liabilities of state-owned enterprises against interenterprise arrears.

D.  Labor Market Policies

13.  We will continue to implement a strict incomes policy for state-owned enterprises. In the second quarter of 1999, implementation was successful: the total wage bill of the 100 monitored enterprises declined by 10.7 percent relative to the wage bill in the third quarter of 1998, and no more than 10 of the monitored enterprises violated the wage bill freeze as we continued strong enforcement, including through fining and firing management in the enterprises with excessive wage bill increases. For the second half of 1999, we have expanded the coverage of the monitored enterprises: besides the state-owned enterprises listed in the 1999 Incomes Policy Decree (100 enterprises with the largest losses and arrears), we now also monitor all state-owned monopolies even if they were not in the original list. For the revised set of monitored enterprises, we have set and will enforce a wage bill freeze (at the level of the third quarter of 1998 for the old list and at the level of the second quarter of 1999 for the new enterprises on the list). Agreement on the 2000 incomes policy will be a condition for completing the third program review.

14.  We recognize the importance of increasing labor market flexibility, and are taking steps to promote employment and maintain competitiveness. We will strengthen training programs that provide skills targeted toward available opportunities, providing professional training, and training under the Temporary Employment Program. We will foster employment by cutting red tape for opening and running businesses, based on the findings of an interministerial study to be completed in October 1999, and by providing training in business management techniques. Moreover, by end-1999 we intend to submit to parliament amendments to the Labor Code that will significantly liberalize regulations in the area of industrial relations while complying with EU and ILO standards. In particular, the Code will reduce required paid leave for education, maternity, and childcare, and facilitate termination of employment for misconduct or economic reasons.

E.  Structural Reform

Privatization and enterprise restructuring

15.  We continue to implement a flexible approach to privatization, employing a wide variety of methods tailored to the size and nature of the enterprise. To date we have privatized over 40 percent of state-owned assets, or over 50 percent of the total assets we believe can be privatized. It is our objective to divest the state of virtually all small, and most large, commercial enterprises by end-1999. For smaller enterprises we have vested the responsibility for privatization in the relevant line ministries and municipalities, and they were able to meet the objective of selling half of the assets under their purview by the first quarter of 1999. This process relies heavily on auctions and management-employee buyouts (MEBOs) which emphasize speed rather than quality or revenue. The last amendments to the Privatization Law reduced the advantages enjoyed by MEBOs, and we are seeking at the beginning of parliament's autumn session passage of a clarifying interpretation of the discount factor for MEBO bids offering deferred payment schemes. For larger enterprises the responsibility for privatization rests with the privatization agency often in cooperation with outside advisors. Apart from the successes we have had with the completion of the isolation program (see next paragraph), we have also recently concluded a number of important deals, including the sale of four pharmaceutical companies to foreign strategic investors. Most important, the sale of BTC, the telecommunications company--the largest privatization in Bulgarian history--has been agreed in principle and will be finalized shortly. We will continue to favor strategic investors with an established corporate profile and international presence. The sale of Neftochim, the largest refinery, is expected by the end of the year; we remain committed not to raise customs duties for refined fuels in this context. The planned privatization of the state tobacco monopoly has been delayed owing to the unanticipated complexity of the process, but we are confident that the company can be brought to the point of sale by end-1999. The second round of mass privatization, offering shares in 189 enterprises, is proceeding smoothly. To date two auctions have been completed and two more are scheduled.

16.  A significant intensification of our efforts and political will during the first half of the year enabled us to successfully meet--and even exceed--our commitments to finish the isolation program for virtually all of Group B (commercial enterprises). Certain enterprises which had been very difficult to sell such as Balkan Airlines and DZU were sold to foreign strategic investors. Other enterprises were sold to MEBOs or entered into liquidation. Of the four enterprises in the defense industry, where we had committed to a solution by end-September, we have sold two, liquidated one, and expect to sell the remaining one within the deadline. This last enterprise will remain in isolation until the privatization deal is completed.

17.  By a Council of Ministers' decree we have effectively extended the isolation program for companies in Group A (utilities). These enterprises are now required to submit by end-September 1999 revised restructuring action plans that meet Minister of Finance approval. A key element to receive such approval will be a financial plan indicating that the enterprise will remain current on all liabilities to the state and that by the end of 2001 it will be able to operate without any state subsidies. In the meantime, we will provide for explicit subsidies in the budget to cover the losses of these companies, and, with the exception of NEK, will restrict their access to bank credit. The increases in electricity tariffs and heating prices and the liberalization of coal prices have already contributed to a sharp improvement in prospects for entities in the energy sector, including Sofia District Heating. This enterprise had been in the isolation program but, given its devolution to the local administration, is formally outside the scope of the new decree. For this enterprise, budget subsidies will be eliminated effective with the year 2000 budget. The second enterprise formally outside the scope of the decree is Sofia District Transport (SDT). This enterprise has also improved its financial situation, owing to the decision of the municipality to require its agencies whose employees or dependents benefit from fare exemptions or reductions to make compensatory payments to SDT. This requirement will be made effective for all state budget organizations--concomitant with the elimination of state budget subsidies--effective with the 2000 budget.

18.  The most problematic enterprise in Group A is BDZ, the national railway, whose losses tripled to US$50 million in 1998. The losses are projected to rise to over US$100 million this year even before consideration of the Kosovo impact, accounting for about three fourths of all the losses of loss making enterprises in Group A. The company also has overdue obligations to the state budget, estimated at US$34 million at end-1998. To improve the operations and financial position of this enterprise, we will ensure that the company fully implements the reforms recommended under the World Bank financed railway rehabilitation project. Specific measures will be covered in a rehabilitation plan to be approved by the Council of Ministers by end-September 1999, and they will include the closure of two unprofitable lines and sections of other unprofitable lines by end-1999; the elimination of most fare exemptions and reductions with effect from January 1, 2000; privatization or liquidation of 13 subsidiaries by end-1999; the sale of at least 10,000 tons of scrap by year end; a wage bill freeze; and a prohibition of new borrowing from commercial banks.

19.  Recognizing that liquidation and bankruptcy procedures need to be accelerated, we are determined to take decisive action to unclog the process. As far as liquidation is concerned, our chief concern is twofold: to immediately stop loss-making activities, and to sell off the assets as speedily as possible in a transparent manner. Given that exit from the isolation program is intended to be permanent, we commit to terminate production activities of all Group B enterprises currently in the process under chapter 17 of the Commercial Code and to sell core assets (accounting for at least 50 percent of long-term fixed assets) in no fewer than half of these enterprises by the end of the year. The liquidation of these enterprises is to be completed by end-June 2000. We also believe the current legislation needs improvement in that it does not facilitate the bankruptcy of insolvent enterprises. To this end, we intend to submit draft legislation by end-September 1999 which will provide for a more rapid and efficient procedure for the liquidation and bankruptcy of state-owned enterprises. We will also endeavor to speed up the bankruptcy procedures by devoting more resources to training judges.

Energy sector reform

20.  The government's strategy for the energy sector has the twin objectives of improving the financial discipline of energy enterprises and developing a market-driven competitive sector. Regarding the first objective, we are determined to impose hard budget constraints on the state-owned enterprises, and to eliminate the practice whereby they build up arrears to the energy sector companies which in turn build up arrears to the state budget. We will break this vicious cycle by taking specific measures to reduce both the outstanding receivables and liabilities of the energy sector enterprises. On the second objective, we regard a viable, competitive energy sector as critical to the medium-term prospects of the Bulgarian economy. To this end, we are committed to a comprehensive restructuring of this sector, in line with the new Energy and Energy Efficiency Act adopted by parliament on July 2, 1999. An independent regulatory commission will be appointed by end-September 1999, and all secondary legislation will be in place by end-March 2000.

21.  We are taking firm measures to ensure that energy sector entities, especially Bulgargaz and NEK, collect receivables in a timely manner. At the end of the first quarter of 1999, the stock of arrears from sales owed to these enterprises was 424 million leva and 131 million leva, respectively. In turn, Bulgargaz owed 273 million leva to the state budget, while NEK has managed to keep its payments current. In early July 1999, we introduced a draft law in parliament that would allow a 370 million leva recapitalization of Bulgargaz at end-September 1999 to settle its liabilities to the state budget, subject to the strict implementation of an action plan for the financial rehabilitation and restructuring of this enterprise (see paragraph 23 below). In turn, Bulgargaz will sign agreements with its debtor enterprises writing off accumulated interest and penalties on the condition that thereafter liabilities remain current. If the enterprises do not comply, Bulgargaz will cut off gas supplies and initiate insolvency proceedings against offenders. NEK will be similarly firm in collecting its receivables, implementing a 1997 decree to cut off electricity supply after 30 days of nonpayment.

22.  Restructuring is well advanced in the electricity sector. We have completed the accounting separation of the generation, transmission, and distribution activities of NEK on schedule, and will establish distinct legal entities for these components by the end of the year. We are currently in the process of privatizing the generation and distribution assets of NEK: the large thermal power plants are being turned into joint-stock companies with the participation of foreign strategic investors. To facilitate the accounting separation of the joint-stock companies, we have created 28 distribution companies, along the lines of the administrative regions. It is our intention, however, to group these distribution companies into larger units by the end of the year to facilitate their sale to strategic investors. To further enhance competition in this crucial sector, we have included a provision in the Energy Act allowing third-party access to the transmission assets of NEK from January 1, 2002.

23.  We are committed to the comprehensive restructuring of Bulgargaz, guided by the action plan approved by the Council of Ministers on June 30, 1999. As a first step, a comprehensive audit in accordance with international accounting standards will be conducted; a tender to choose an auditor will be issued by mid-August, and we expect to receive the final audit report by end-1999. Also by the end of this year, we intend to complete the accounting separation of the import, distribution, and transport components of this monopoly. Differentiated tariffs for the transport and distribution of natural gas will be introduced in January 2000. Our medium-term strategy for Bulgargaz entails the creation of regional gas-distribution companies with the participation of foreign strategic investors. In consultation with the World Bank, we will develop the specific details of this strategy in a fully elaborated program, with a detailed timetable for implementation. This plan will be approved by the Council of Ministers by end-September 1999. We also plan to eliminate the monopoly of Bulgargaz in the import of gas by 2006.

24.  We will continue with the restructuring and financial rehabilitation of the district heating companies (DHCs), including through raising prices so as to reduce subsidy needs. Bearing in mind the lower-than-expected inflation, the accelerated restructuring measures that have been implemented over the past six months, and the high rates of disconnection that resulted from the large price increases last year, we decided to raise prices with effect from July 5, 1999 by 12 percent, rather than the planned 30 percent. This lower increase still allows the district heating companies to limit their subsidy needs to the budgeted amount for 1999. As part of the overall restructuring strategy, we aim to install metering and control devices at the individual apartment level so that each household pays only for actual heat consumed and has the ability to control the heat. Also, the Energy Law has provided the basis for private investors to contract with DHCs for more efficient production of heat and electricity. Moreover, in line with our overall financial rehabilitation strategy, we will make efforts to reduce the outstanding liabilities and receivables of the district heating companies. As for the overdue receivables, we will take every effort to secure payment, including cutting off heat supply to the nonhousehold sector. We are continuing to split off the noncore activities of the district heating companies into separate enterprises which we plan to gradually privatize or transfer to those municipalities which are willing to take them over.

25.  As regards coal mines, we are determined to close the unviable sections of mines by the end of 1999. We estimate that the workforce in state-owned mines will decline by about 8,200 during 1999 and that 14 percent of the long-term assets of the coal mines will be liquidated by the end of 1999.

Financial sector reform

26.  We remain strongly committed to privatizing the state-owned banks. Despite the recent unfavorable external conditions, we are well advanced in the sale of three more state banks. On Expressbank, following due diligence by the shortlisted potential buyers, binding bids were received on July 9, 1999, and we are now at the final negotiation stage. On Bulbank, our largest bank, we are forming the shortlist of potential buyers who will be entitled to perform due diligence on the bank, and in late June invited final bids to be submitted by October 15, 1999. We have also made progress in the sale of Hebros. Potential buyers are currently performing due diligence, and we intend to announce in August a deadline for binding offers. The privatization of Biochim and the State Savings Bank (SSB) is also planned to take place in the period ahead. We have decided to accelerate the privatization of Biochim. We are now committed to issuing a tender for that bank by end-1999, and expect that the bank will leave the public sector by end-March 2000. The SSB has started to implement a technical assistance program to improve its operations and performance in preparation for its eventual privatization.

27.  We will continue to improve bank supervision and prudential regulations. On supervision, in the first half of 1999 we conducted full inspections of 6 banks and assigned CAMELS ratings to them. We plan to complete the assignment of such ratings to all banks in Bulgaria by the end of the year. In addition, we have set up an early warning system aimed at monitoring the banks' activities closely on a monthly basis. We will further develop this system and harmonize it with CAMELS. Moreover, we will prepare quarterly reports on the state of the banking sector; the first report covering the first half of this year is expected to be completed by end-August 1999. In parallel, we are enhancing our monitoring by establishing elements of consolidated supervision. The relevant draft regulation has been completed, and we expect that the regulation will be adopted by end-1999, with the aim of implementing full consolidated supervision by end-2000. On prudential regulations, the process of closing a bank in January 1999 had revealed some weaknesses in our prudential regulations that did not allow us to close the bank even earlier. We have since prepared revised draft regulations that address the identified problems, and the BNB intends to adopt them by end-September 1999.

28.  We are implementing a two-track system to handle bank insolvencies. To accelerate the liquidation of 11 already closed banks where the government is the main creditor, we have added transitional provisions to the amendments to the Banking Law. These provisions became effective in June, and we expect the remaining assets of the 11 banks to be transferred to the government by October 1999. For future insolvencies, the Bulgarian National Bank and the government are preparing a new draft law that provides for bankruptcies of banks to be handled by an administrative system, managed by the Deposit Insurance Fund (DIF). We expect to submit the draft law to parliament by end-March 2000, and will ensure that the DIF will have adequate capacity to assume the added responsibilities.

Agricultural sector policies

29.  We will take further steps to develop a well-functioning agricultural land market. By mid-1999, land restitution had reached 95 percent, compared with 80 percent at end-1998, and we expect its completion by end-1999. The titling process has also accelerated recently as decisions of the regional land commissions and associated documentation now have the same legal status as a court-issued title. By end-June 1999, 30 percent of the restituted land had titles, up from 18 percent at end-1998, and we believe that the completion of the process by the end of the year is within reach. All important restrictions on land leasing were removed by early 1999, and legislation to create a land cadastre and a unified registry of land ownership has been submitted to parliament, with adoption of this legislation expected by October 1999. With these measures, we expect that transactions in the agricultural land market will increase markedly in the coming months. We will develop a monitoring system to measure the number of sales by end-1999.

30.  The government has pushed ahead with the privatization and liquidation of agricultural assets. Of the total long-term assets under the jurisdiction of the Ministry of Agriculture, two thirds have been privatized or liquidated, and we expect the process to be completed by March 2000. The privatization of the assets of Zarneni Hrani is also proceeding rapidly, and we will close this enterprise as a legal entity by the end of 1999.

31.  We are committed to facilitating bank lending to agriculture and reducing the role of the State Fund for Agriculture (SFA) in the provision of rural finance. To this end, we have reduced the short-term lending by the SFA from 46 million leva in 1998 to 34 million leva in 1999, and will phase out such short-term lending by end-2001. While it is clear that the rural credit market is underdeveloped at the present time, we nonetheless acknowledge that the role of the SFA in alleviating this problem must be limited. Accordingly, we view the purchase of 35 percent of the shares in the Central Cooperative Bank (CCB) by the SFA as a temporary solution to the problems facing commercial banks in implementing SFA programs, and will reduce the stake of state entities in the CCB to under 50 percent by mid-2000 and to below 33 percent by mid-2001. We will also impose an upper limit of 58 million leva on the amount of long-term credit extended by the SFA in 1999, including that intermediated through the Central Cooperative Bank. To foster a private sector rural credit market, we have taken steps to develop a warehouse receipts system, including ensuring that a sufficient number of warehouses will be licensed to provide the capacity to handle the demand for warehouse receipts, and stand ready to take action should any impediments to its implementation arise.

Improving statistics

32.  Recognizing the importance of high-quality and timely statistics to guide policy formulation, we are committed to devoting more resources to the compilation and publications of statistics by the National Statistical Institute and the Bulgarian National Bank. Although the publication of a monthly industrial production index was delayed for technical reasons, we have started publishing this index from June 1999. We have also established the methodology for conducting a quarterly financial sector survey and identified the technical assistance needs. We will seek appropriate technical assistance to implement this survey in a timely manner. The improvement in external sector statistics also remains a priority, and we will implement the key recommendations of the June-July 1999 IMF technical assistance mission in this area speedily. More generally, we are committed to fully implementing the General Data Dissemination System (GDDS) by the end of 2000.

F.  External Sector Policies

33.  We will make strong efforts to secure the external financing needed to support our ambitious adjustment and reform program. For 1999-2001, we estimate the financing needs to amount to US$1.6 billion. Our financing strategy continues to rely on an accelerated structural reform program to attract significant foreign direct investment, and on official external financing. With improved prospects for foreign direct investment following the end of the war in Yugoslavia and provided the pledges made in the Joint Consultative
Group/G-24 meeting in Brussels in April 1999 materialize, we expect the financing needs for 1999 to be largely covered. However, there are financing gaps for the subsequent years for which we will in due course seek additional official financing should foreign direct investment and other private financing prove insufficient.

34.  To overcome the weakness in export performance and enhance competitiveness, we intend to intensify the program of trade liberalization. Our earlier commitments for measures to take effect from the beginning of 2000 already included significant steps: abolishing the remaining export taxes and import licensing requirements, lowering the average tariff level, and continuing the privatization of the remaining state trading enterprises. Beyond this, we will make further reductions in the maximum tariff rates in industry (to 30 percent) and in the number of tariff bands (from 37 to 25) effective from January 1, 2000. With these changes, the average tariff for agricultural goods will fall from the present 26 to 24 percent, and that for industrial goods from 13 to 11 percent. To indicate our commitment to a transparent and open trade regime, no increases in tariffs will be made outside the annual Trade Decrees. Competitiveness of exports should also benefit from the recently adopted duty-draw back scheme.

35.  We will follow through on several initiatives underway in external debt management. First, to improve the management of external liabilities, lower the external debt burden, and facilitate Bulgaria's entry to private international capital markets, we will prepare a medium-term debt management strategy by March 2000. This strategy will aim to strengthen our ability to assess external vulnerability and develop guidelines for managing the external position in the medium term. Already from the beginning of next year, we will publish a set of external vulnerability indicators. Second, we will undertake debt management operations only if overall liquidity is sufficient and there are adequate reserves in the FRA. Given the adverse conditions in international financial markets, we do not plan any Eurobond issue for 1999. We will pursue debt service swaps for infrastructure or environment with Paris Club creditors. To facilitate this, we will continue our efforts to resolve all outstanding bilateral disputes with Paris Club creditors. Third, to improve transparency and accountability of public debt management, we will reform existing institutional arrangements. We will remove bilateral debt from the list of state secrets, and start publishing detailed annual debt and debt management reports. To prevent an excessive build-up of contracting and guaranteeing of nonconcessional public debt, we will by end-September 1999 establish guidelines to identify priorities and define criteria for the selection of projects within the agreed ceilings.

36.  To further integrate Bulgaria into the global economy, we have reviewed our regulations on capital account transactions. In our assessment, the banking system is sufficiently sound to withstand further capital account opening. Accordingly, we have submitted to parliament a draft Foreign Exchange Law that provides for a significant liberalization of the capital account. We expect the new Law to take effect by end-1999.

G.  Program Monitoring

37.  During the second year of the extended arrangement, the program will be monitored based on the implementation of structural performance criteria and benchmarks (Tables 1 and 2), and on quarterly and continuous quantitative performance criteria and indicative targets, set on a cumulative basis from end-December 1998. The government will conduct with the IMF a mid-term review of the program no later than end-March 2000. The quantitative performance criteria include: (i) ceilings on the deficit of the general government (Annex I); (ii) floors on the balance of the FRA (Annex II); (iii) floors on the deposits of the banking department (Annex III); (iv) ceilings on overdue tax obligations (Annex IV); and (v) ceilings on the stock of external debt of 1 year and under, and on public contracting and guaranteeing of external debt with an original maturity over 1 year, and 1-5 years (Annex VI). Indicative targets include (i) floors on revenues of the general government (Annex I); (ii) ceilings on overdue customs and social security obligations (Annex V); and (iii) ceilings on the cumulative change in net credit from the banking system to the general government (Annex VII). Other performance criteria--applicable on a continuous basis--remain as defined in the Memorandum of September 9, 1998 (Annex VIII).

1All domestic currency figures in this memorandum are in terms of new leva. On July 5, 1999 the lev was redenominated by removing three zeroes. As a result, one lev now equals one deutsche mark.