Azerbaijan Republic and the IMF |
Press Release: IMF Approves US$18 Million PRGF Disbursement to the Azerbaijan Republic and Requests for Waivers of Performance Criteria and Extension of Arrangement
May 15, 2003
Country's Policy Intentions Documents
Azerbaijan Republic—Letter of Intent
Mr. Horst Köhler
Dear Mr. Köhler:
1. On February 20, 2002, the IMF Executive Board completed the first review under Azerbaijan's Poverty Reduction and Growth Facility (PRGF) arrangement, which is in support of our three-year economic program. We would like to take this opportunity to inform you about our continuing implementation of this program, as well as our policy intentions for 2003, to propose performance criteria, indicative targets and structural benchmarks for end-June, end-September and end-December 2003, to request waivers for non-observance of several structural performance criteria, and to request the completion of the second review under our PRGF arrangement. This letter should be read as additional to our original letter of intent and Memorandum of Economic and Financial Policies, dated June 15, 2001, as well as our second letter of intent, dated February 6, 2002.
2. In view of the delay in completing this second review, we hereby request that the third review be rephased, and that it be based on our economic performance as of end-June 2003, with subsequent reviews every six months. This would result in the final test date under the program being end-December 2004, and thus we request that the arrangement be extended to March 31, 2005. Our performance relative to the quantitative performance criteria and indicative targets for 2002 is presented in Table 1, and the proposed quantitative performance criteria (for end-June and end-December 2003) and indicative targets for end-June, end-September and end-December 2003 are detailed in Table 2. The third and fourth reviews are scheduled for completion by August 15, 2003 and Feburary 15, 2004, respectively, Performance relative to these targets and criteria will be measured as detailed in Annex I. These performance criteria are consistent with those previously identified under the program, with one important exception. Consistent with best practices for oil exporting countries, we are increasingly focusing our attention on the non-oil fiscal deficit—the consolidated deficit minus cash revenues from the oil sector—and we propose that the fiscal performance criterion under the program be determined based on this concept, which will help us to avoid excessive dependence on oil revenue.
3. The quantitative performance criteria and indicative targets, as well as our program policies and objectives, as described below, are fully consistent with our State Program for Poverty Reduction and Economic Development (PRSP), which has recently been finalized, and approved by the President of the Azerbaijan Republic, Mr. Heydar Aliyev. This program was prepared in close consultation with civil society and parliament, and will now form the basis for all our economic reform efforts.
4. All quantitative performance criteria under the program for end-March 2002 and end-September 2002 were met. Macroeconomic indicators continue to be consistent with program targets; real GDP growth in 2002 was 10.6 percent, compared to the program target of 8.5 percent. Period average consumer price inflation for 2002 was 2.8 percent, compared to our target of 2.4 percent. All indicative targets for end-March, end-June and end-September 2002 were met as well, except for the targets on budgetary expenditure arrears for end-March and end-June 2002, which were missed by small amounts; by end-September 2002, the level of budgetary expenditure arrears was below the program's indicative target.
5. Indicative targets for end-December 2002 related to net credit to the government, net domestic assets of the National Bank (ANB) and the consolidated government deficit were missed by small amounts. This was due to actions taken to finance Azerbaijan's share of the Baku-Tbilisi-Ceyhan (BTC) oil export pipeline. While our PRSP program recognizes, and strongly emphasizes, the critical importance of timely construction of the BTC pipeline, the need for such expenditures by the government, as well as their timing and magnitude, were not known at the time of the last review by the IMF Executive Board of our program performance. The financing of these expenditures was undertaken in close consultation with the Fund staff, to ensure consistency with our program objectives.
6. We continue to believe that the real growth and inflation targets for 2003, as spelled out in the first review of our program, remain broadly appropriate. We currently project real GDP growth in 2003 of 9.2 percent, and will target end-period CPI inflation of 2.5 percent. Our monetary and fiscal policies for 2003 have been designed to be consistent with these targets. However, in the current environment of high uncertainty and instability in oil prices, we recognize that there is a greater than usual risk in achieving our goals. The macroeconomic framework underlying this letter differs slightly from that in our PRSP, as it was finalized more recently and thus reflects the latest information on factors such as oil prices, However, it is fully consistent with the objectives and policies in our PRSP.
7. As a result, we are preparing contingency plans to be implemented in the event that oil prices turn out to be either much higher or much lower than currently projected, and will discuss these plans carefully with Fund staff. In the event of much higher prices, the budget will save additional tax revenues, as discussed below. In addition, we will consider requiring SOCAR to use any additional after-tax revenue it receives from these higher oil prices to pay its tax arrears from previous years, and encourage SOCAR to review, jointly with the ANB, the possibility of saving any remaining excess earnings abroad in order to avoid adverse macroeconomic impacts of the foreign exchange inflows. In the event of modest declines in oil prices, these could be accommodated by drawing down on the higher revenues saved early in 2003 from high oil prices. If prices decline sharply, so that average 2003 oil export prices are significantly below the budgeted level, we will consult with Fund staff in working out our response. We have also begun, in consultation with Fund and World Bank staff, to prepare medium to long term plans for the use of the growing oil and gas revenue. In particular, we will consider during 2003 the future role and use of funds saved from the above-budget SOCAR tax payments.
Progress on Structural Reforms
8. Structural reforms have been broadly in line with our program commitments. However, some important structural measures took longer to implement than envisioned in the program, and thus we must request several waivers related to structural performance criteria under the program. The timetable for the reduction in the number of specific import tariffs was adopted by end-March 2002, as called for under the program, and we have begun implementing that timetable. The first two steps were taken on October 1, 2002 and April 1, 2003, converting specific tariffs for 19 product categories to ad valorem tariffs. These changes have also reduced the weighted average tariff in Azerbaijan significantly, from 7.9 percent in 2001 to much closer to our target of 6.5 percent. The final two steps will be taken on October 1, 2003 and April 1, 2004, after which specific tariffs will only apply to excisable goods.
9. Despite significant progress in other structural reforms, timetables for the unification of domestic and world market energy prices, as well as for the privatization of the International Bank of Azerbaijan (IBA) and United Universal Bank (BUS Bank), took longer than anticipated to design and approve. These timetables have now been adopted, in consultation with the Fund staff, and are being implemented. We have recently increased the domestic prices of natural gas, gasoline, fuel oil and most oil products (except kerosene and diesel fuel) to estimated long run import or export parity, as appropriate. The price of diesel fuel has recently been increased, but not to world market levels. In addition, as a result of reforms of SOCAR, crude oil is no longer sold in the domestic market. We have also adopted, via presidential decrees, timetables for the privatization of IBA and BUS Bank, as discussed below. We thus request waivers for these two end-March 2002 structural performance criteria.
10. In addition, we have allocated subsidies to Azerenergy and Azerigas, and offsetting tax credits to SOCAR (the State Oil Company of the Azerbaijan Republic), for the amount of fuel delivered to these utility companies but not paid for by them, for all of 2002, we have published information on these subsidies and tax credits, and we have included these subsidies and tax credits in published reports on the execution of the consolidated budget. However, administrative difficulties prevented us from taking these actions on the timely basis envisioned in the program. We have now designed a new procedure for the timely allocation of these tax credits and subsidies, in consultation with Fund staff, and therefore request waivers for the relevant performance criteria. These subsidies have for the first time been included in the 2003 state budget approved by parliament, converting what had previously been quasi-fiscal subsidies into budgetary subsidies.
11. These steps are key elements of our comprehensive program to strengthen financial discipline in the energy sector. Other elements of that program that we have implemented in the last year include the full payment by budgetary organizations, for the first time in recent years, for their utility consumption in 2002. In addition, following the successful introduction of private management for our largest electricity distribution network in 2002, which contributed to a substantial increase in collection rates (although these rates nonetheless remain far too low), by end-2002 we had signed management contracts for the three remaining electricity distribution networks.
12. We have also recently announced, and are in the process of implementing, a restructuring of SOCAR, designed to improve financial transparency and more clearly identify which parts of SOCAR are operating efficiently and which need further reforms. The process of privatizing parts of SOCAR's operations, particularly those not directly related to its core operations, have begun, with companies employing in total 10,000 people separated from SOCAR and privatized in 2002.
13. Structural reforms have also been broadly in line with structural benchmarks under the program. Most importantly, a new Budget Systems Law was designed in close cooperation with the staffs of the Fund and World Bank. This law has now been adopted, and we are working to implement it, in consultation with Fund staff. We have also continued to work—with the assistance of the IMF, the World Bank and the United States government—on computerization of our treasury system.
14. In addition, we have continued our efforts to strengthen the customs and tax administration systems. A reform program for the State Customs Committee (SCC) was adopted in early 2002, and has been aggressively implemented since then. Key elements of this program have included the introduction of customs brokers and bonded warehouses. In the Ministry of Taxes, we have an ongoing program to improve administration; the most significant step we have taken recently was the reduction in Ministry staff by 40 percent, combined with an increase in all salaries by either 100 or 200 percent. This is designed to reduce the incentive for corruption and provide enhanced incentives for strong performance. In addition, the number of local offices has been substantially reduced, and we have strengthened the operations of local offices by improving headquarters' surveillance of their operations, and by preparing, disseminating and training office staff in standard procedures for taxpayer registration, return filing and payment, audit and collection enforcement. We have also strengthened the Large Taxpayer Unit, and initiated the process of full automation of tax offices. While a draft new Banking System Law has been designed, in cooperation with Fund staff, it took longer than anticipated to complete, and thus has only recently been submitted to the parliament.
15. We have made considerable progress in strengthening the regulatory framework of the banking sector, including through the issuance of 13 new or revised prudential regulations conforming to best international practices, including risk-based capital, loan loss provisioning and asset classification regulations. Some of these regulations are being upgraded to bring them fully in line with international best practices, with the help of USAID technical assistance. We have also continued to expand further our range of monetary instruments. During 2002 the ANB introduced repurchase and reverse repurchase of treasury bills, and in early 2003 we created an instrument allowing banks to place interest-bearing deposits with the ANB, to be used to withdraw excess liquidity. A small value payment system was introduced in November 2002, which will significantly increase the range of banking services offered to small businesses and households.
16. Based on an assessment of opinions of domestic and international investors, the government has in 2002 taken significant steps to improve the business environment, beyond the tax and customs administration reforms discussed above. Most importantly, the number of business activities requiring licenses has been dramatically reduced, and the process of receiving licenses for the few remaining industries requiring them has been streamlined. To further improve transparency, we have also adopted a new Constitutional Law, requiring the government to report to parliament early each year about the government's activities in the previous year.
Economic Policies for 2003
17. Fiscal policy in 2003 will be driven by our desire to improve our domestic infrastructure and to more adequately compensate civil servants and pensioners, consistent with the objectives expressed in our PRSP (Appendix 2). While some of the additional expenditures will be financed by higher non-oil revenues, the planned increases will also require slightly greater usage of oil revenues. As a result, our non-oil deficit (the overall fiscal balance, excluding oil-related revenue) will increase by 1.1 percent of GDP, to 10.8 percent of GDP. This non-oil deficit remains well below the long-term sustainable level.
18. We have a comprehensive agenda of fiscal reforms that we intend to implement in 2003. The most important is the continuing development of the State Oil Fund of Azerbaijan (SOFAZ). In this context, we intend to take steps to enhance the legislative foundation of SOFAZ and further integrate the oil fund and state budgets. In particular, and as a prior action for the proposed completion of the IMF Executive Board's second review of our PRGF arrangement, we have submitted to parliament amendments to the Budget Systems Law, prepared in consultation with Fund and World Bank staff, that will (i) call for parliamentary approval of the deficit and expenditure ceilings of the consolidated budget (with the consolidated budget defined to include the state budget, budget of the Social Protection Fund and budget of the Oil Fund, excluding Oil Fund revenues; (ii) require that all expenditures in the consolidated budget (except for expenditures on the management of the oil fund and its assets) be executed by the treasury, and that all capital expenditures be part of the State Investment Program; (iii) assign responsibility for the preparation of the consolidated budget to the Ministry of Finance; (iv) ensure that extra-budgetary funds do not make portfolio investments in domestic commercial activities or issue loans or loan guarantees; and (v) require that SOFAZ hold equity positions only through highly rated professional portfolio managers in international markets. We propose that the adoption of these critical amendments by end-June 2003 be a structural performance criterion for completion of the third review under our PRGF arrangement.
19. In conjunction with these amendments, we have proposed additional amendments designed to improve the Budget Systems Law. These amendments will clarify the jurisdiction of the Chamber of Accounts over the operations of the consolidated budget, as well as extra-budget funds and budgetary organizations; clarify that the Ministry of Finance, working in close cooperation with the extra-budgetary funds and the Chamber of Accounts, has the authority to prescribe uniform reporting formats for the state extra-budgetary funds and budgetary organizations; clarify that the Ministry of Finance has exclusive control over government banking arrangements; and preclude municipalities from market borrowing. We will also work in 2003 to strengthen our Medium Term Expenditure Framework and State Investment Program (SIP) for 2003-05, which has recently been adopted, ensuring they reflect the priorities and objectives of our PRSP, and that the 2004 budget is consistent with these documents (PRSP, Section 4.1). Finally, working in close consultation with Fund and World Bank staff, we will design procedures for the effective implementation of the new Budget Systems Law, including the development of sound procedures for consolidated budget preparation. In that context, we will consider the establishment of a commission, under the aegis of the Cabinet of Ministers, to determine the priorities of the annual and medium-term budgets.
20. During 2003, we will work to design, in consultation with the World Bank, mechanisms to compensate the poor for planned increases in 2004 in kerosene and diesel fuel prices, as well as the eventual elimination of the implicit and explicit utility subsidies (PRSP, section 3.1). We have also taken steps to strengthen Ministry of Finance oversight of the fiscal affairs of municipalities, including by assigning responsibility for municipal affairs to an appropriate official in the Ministry.
21. With the 2003 state budget, we have completed the process of subjecting all taxpayers to the tax legislation. Prior to 2001, large state owned enterprises paid taxes according to a pre-determined tax target, independent of the tax laws. In 2001, all these enterprises were required to begin paying taxes according to the tax legislation. However, it was at that time impossible for SOCAR to adhere to the tax laws while simultaneously providing substantial quasi-fiscal subsidies to the utility companies. Now that the cost of these subsidies is borne by the state budget, and not by SOCAR, the company has been instructed that it, too, must pay taxes according to the laws of the country, and do so in a timely fashion. In addition, during 2002 and with the assistance of the Fund, we will review the tax laws as they apply to SOCAR, and possibly amend those laws based on international best practices for taxing state-owned oil companies.
22. SOCAR's tax payments will now depend on changes in oil prices. In the current environment of high oil prices, the Ministry of Finance will save any tax payments from SOCAR in excess of that anticipated in the approved budget, including any cash payments of pre-2003 tax arrears. Should oil prices fall in the future, resulting in SOCAR tax payments below budgeted levels, these saved funds will then be used to offset the shortfall in revenues. The performance criteria related to net credit to government and net international reserves of the ANB will be adjusted accordingly based on the actual oil export prices, as specified in Attachment 1. During 2003, in consultation with Fund staff, we will develop a long-term strategy for the use of these saved funds.
23. We are committed to developing the regions of Azerbaijan (PRSP, section 4.3). As a first step, in 2003, we introduced regional and sectoral variations in the enterprise profit tax rate. The tax rate now varies from 25 percent in Baku to 10 percent in mountainous regions. During 2003, we will design a more effective and comprehensive program for development for regional development, consistent with our State Program on Poverty Reduction and with technical assistance from the staffs of the Fund and World Bank. In the context of the 2004 state budget we will submit to parliament proposals to reunify the enterprise profit tax rate, at a level determined in the context of the budget preparation and based on our analysis of the 2003 experience.
24. To date, exemptions to the value added tax (VAT) have been granted by the Cabinet of Ministers in a series of independent decisions. While each decision has been well motivated, the combined result has been an excessively long list of exemptions. To provide greater coherence to the process of determining VAT exemptions, and ensure that the impact of these exemptions is fully reflected in budget revenue forecasts, we will (i) request technical assistance from the Fund in reviewing our exemptions policies; (ii) in the context of the 2004 budget, and based on the recommendations of the technical assistance mission, substantially reduce the existing list of VAT exemptions, and (iii) commit that future changes to the list of VAT exemptions will be approved only in the context of annual budget preparation process, and be implemented at the same time as the new budget takes effect.
25. More generally, we plan to improve our procedures for revenue forecasting. We will establish a revenue forecasting commission under the aegis of the Cabinet of Ministers, and including representatives of the Ministry of Finance, Ministry of Taxes, State Customs Committee (SCC), Ministry of Economic Development, State Statistics Committee, SPF, SOFAZ, SOCAR, and ANB. This committee will be tasked with producing annual revenue forecasts, including preparing careful assessments of the revenue implications of any tax policy proposals, in line with the requirements of the new Budget Systems Law, prior to their consideration by the Cabinet of Ministers.
26. Finally with regard to revenues, we will continue our efforts to improve tax and customs administration (PRSP, section 4.1). Consistent with this effort, we are in the process of producing performance indicators for the Ministry of Taxes (designed in consultation with Fund staff), and will use these indicators in the future to assess the performance of the ministry. We will shortly adopt improved regulations for VAT refunds, to ensure the timely payment of such refunds. In the SCC, we will continue to implement the reform program which was designed on the basis of the external evaluation of the committee which was done in early 2002. Having largely completed the short and medium-term reform efforts, we will now turn our attention to the longer term reforms identified in this program, and have adopted a timetable, in consultation with Fund staff, for the implementation of these long-term reforms. We will also continue the process of replacing specific with ad valorem customs duties, implementing the third of four steps in our timetable on October 1, 2003.
27. In the 2003 budget, we have eliminated the earmarking of revenues for some extra-budgetary operations of budget organizations. For all budget organizations that continue to have authority to spend fees and other revenues they earn, we have integrated these funds into the state budget, and their spending plan was approved as part of the process of approving the state budget. We will continue our efforts to gradually reduce all remaining earmarking and thus more comprehensively integrating these funds into the state budget (PRSP, section 4.1).
28. We are also continuing our efforts to eliminate all quasi-fiscal subsidies (PRSP, section 5.1). In 2002 we eliminated all preferential utility and transport tariffs, replacing preferential tariffs for internally displaced persons (IDPs) and refugees with explicit budget subsidies. In the 2003 state budget, we have included the quasi-fiscal subsidies previously provided by SOCAR to Azerenergy and Azerigas, and we have added an explicit subsidy from the budget for Azerchemia and informed SOCAR that they are no longer expected to provide fuel to Azerchemia without payment. During 2003, we will identify all remaining quasi-fiscal subsidies, of whatever kind, including those provided to the Baku metro, and either eliminate them or provide cash financing for them in the state budget in 2004, thereby completing the difficult but important process of eliminating quasi-fiscal subsidies. We will also issue no new instructions requiring SOCAR to finance IDP-related expenditures or other expenditures that should be financed by the budget. Starting January 1, 2004, SOCAR will no longer provide any quasi-fiscal subsidies.
29. Finally, while we currently do not expect the government to have to pay additional funds for the construction of the BTC pipeline, should that prove necessary, we will consult with Fund staff on the procedures for financing these expenditures.
Domestic and External Debts
30. In 2003, we will strengthen our debt management system (PRSP, section 4.1). We will assign responsibility for maintaining a database on debts to an appropriate state body, in coordination with the State Department of Statistics. This agency will, during 2003, with the assistance of Fund staff, seek to establish a comprehensive database, including not only government and government-guaranteed external and domestic debts, but also external and domestic debts of state-owned enterprises.
31. Current rules largely limit the scope for ministries, other than the Ministry of Finance, to borrow funds. However, according to existing rules, there are circumstances under which line ministries may borrow from domestic banks, and under which borrowed funds can be spent outside the treasury system. We will, in conjunction with other amendments to the budget systems law discussed above, submit an amendment which clearly prohibits domestic borrowing by any ministry financed by the budget, other than the Ministry of Finance, and requires any funds borrowed by the Ministry of Finance to go through the treasury and be reflected in the state budget.
32. Finally, we will continue to be cautious in contracting external debts, adhering to the debt ceilings in Table 1, and will not contract or guarantee loans for commercial purposes. We are continuing our efforts to resolve disputed external debt obligations with Kazakhstan, Turkmenistan and Uzbekistan, and plan to discuss these matters during the forthcoming meetings of the Azeri-Kazakh and Azeri-Uzbek commissions in 2003.
Pension Reform and Social Assistance
33. We are determined to strengthen our SPF, which is responsible for pensions and most social support payments. First, we are taking steps to improve revenue collections. We have begun the important task of seeking to ensure that all taxpayers registered with the Ministry of Taxes are also registered with the SPF, thereby broadening the tax base. We have also issued a Cabinet of Ministers decree instructing all state-owned enterprises—including SOCAR, Azerenergy, and Azerigas—to ensure the timely payment of their obligations to the SPF. Specifically, they have been instructed to ensure that each month, when they pay their wages, they simultaneously transfer to the SPF funds sufficient to satisfy that month's SPF obligations.
34. We have also begun work on a substantive reform of our pension system in accordance with our Pension Reform Concept, and with the assistance of the World Bank and UNDP (PRSP, section 3.1). There are three components to our current reform efforts. First, we have passed a law calling for the establishment of individual social insurance accounts, and plan to have these established for all workers by end-2004. Second, we will reform the system of administering pensions. Currently, the SPF is responsible for collecting pension and allowance revenues, while the Ministry of Labor and Social Protection is responsible for calculating pensions and allowances and making payments to beneficiaries. This division of responsibilities is inefficient, and with assistance from the World Bank, we will unify these responsibilities in one agency during 2004. In addition, in order to ensure timely payment of pensions with minimum inconvenience to the recipients, we are in the process of introducing an automated payment system, whereby individuals will be able to access their monthly pension payments through a bank card.
Monetary and Financial Sector Reforms
35. We will continue in 2003 to implement a monetary policy aimed at domestic price stability (PRSP, section 4.1). Exchange rate policy will likewise be unchanged, with the market allowed to determine the path of the exchange rate and the ANB intervening only to smooth out temporary fluctuations. We believe that the monetary instruments already at ANB's disposal are sufficient to sterilize the impact of planned SOFAZ spending as well as oil-related Foreign Direct Investment. The ANB will monitor macroeconomic developments closely, and act to ensure the maintenance of Azerbaijan's macroeconomic stability. The government will support the ANB in this effort, including by coordinating financial transactions and ensuring that the Ministry of Finance and SOFAZ provide the ANB with monthly updates of their expected pattern and volume of foreign exchange transactions in 2003. To assist in this effort, the government has instructed SOCAR to provide each month, to the government and to the ANB, an updated forecast of SOCAR's cash flow for 2003.
36. We are determined to strengthen the competitiveness and health of our banking system (PRSP, section 4.2). In 2002, we conducted a review of factors inhibiting competitiveness in the banking sector in Azerbaijan. Two factors stood out: first, the market continues to be dominated by the state-owned banks—IBA and BUS Bank. The second problem is related to difficulties in lending stemming from problems enforcing the bankruptcy law, inadequate regulations relating to the use of collateral, the limited use of International Accounting Standards (IAS) outside the banking systems, and continuing problems with the judiciary system.
37. With regard to the dominance of IBA and BUS Bank, we will proceed along three lines to reduce this problem. First, we will move aggressively to privatize these banks (PRSP, section 4.2). New presidential decrees—calling for the sale of 20 percent of IBA to EBRD during thesummer of 2003 (which would reduce the government's share to just over 30 percent), the full privatization of IBA by end-2004, the completion of steps to strengthen BUS Bank in 2003, and the privatization of BUS Bank in 2004—have recently been issued. In the case of IBA, the government has entered into intense discussions with EBRD, with the aim of reaching agreement on the sale of 20 percent of IBA by end-June 2003, and is committed to tendering the remaining shares for sale no later than end-2003.
38. Second, we recognize that even after the privatization of these banks, they will continue to dominate the banking system. One advantage these banks continue to have stems from the government's tendency to use these banks exclusively in providing services to the government. To resolve this problem, the government has begun preparing to issue tenders for the provision of banking services to the government and will during 2003 determine, in consultation with Fund staff, a date by which all banking services to the government will be contracted solely on the basis of competitive tenders.
39. To address the problems in lending, the government will, with the assistance of the World Bank, review the Bankruptcy Law with the aim of identifying problems in this law and associated regulations, revising them and submitting amendments, if necessary, to parliament during 2004. We will also work to establish the institution of receivers, improve the training of judges in bankruptcy procedures, and shorten the processing of bankruptcy cases. At the same time, and also with the assistance of the World Bank, we will review and revise as necessary the rules and regulations related to the registration and use of collateral. In particular, we will simplify the procedures for registering collateral and improve the tax treatment of sales of collateral, to ensure that only profits earned from the sale of collateral are subject to profit tax. The government has launched a comprehensive program, designed to accelerate the introduction of IAS accounting (PRSP, section 4.2). In this context, we will prepare in 2003, in consultation with the World Bank, a new Law on Accounting, and a program for the introduction of IAS standards in state-owned enterprises, as the first step toward requiring IAS accounts in all state-owned enterprises. We will also continue our efforts to strengthen the judiciary system.
40. Third, to demonstrate our openness to international banks, by end-June 2003 we will eliminate the ceiling on foreign bank participation in the Azeri banking system (PRSP, section 4.3).
41. We will also seek to strengthen the state securities market for treasury bills, and the development of manat financial markets more generally. A commission consisting of representatives of the Ministry of Finance, ANB and State Committee for Securities has been created and charged with guiding this effort. Among other steps, in consultation with Fund staff, we will review the registration system for treasury bills and ANB bonds, and at a minimum significantly simplify this system. We will also create conditions for equal access to treasury bill markets for all potential participants, consider the introduction of new types of securities denominated in local currency, and ensure enhanced disclosure of information related to the state securities market.
42. We have prepared, with the assistance of the Fund, a new Banking System Law, which has now been submitted to parliament. In order to further strengthen confidence in the banking sector, we also intend to introduce a deposit insurance system, but not earlier than January 2005. The fulfillment of the preconditions for introducing deposit insurance, including the capacity of bank supervision to meet international standards, will be assessed in close consultation with Fund staff. To that end, during 2003 and 2004 we will continue to strengthen bank supervision and will review the current draft deposit insurance system, with assistance from Fund staff. The draft Banking System Law specifies that the deposit insurance scheme will be activated not earlier than 2005 and only if all participating banks fulfill a set of prudential standards and requirements, as specified by appropriate regulations issued by the ANB.
43. We will also continue our efforts to strengthen the operations of the ANB. Toward that end, we will prepare a revised Central Bank Law (PRSP, section 4.3), in consultation with Fund staff. In light of the importance of such a law, we will take time to ensure the preparation of a high quality law, and will submit this law to parliament sometime in 2003. We attach high priority to enhancing training of ANB staff, and to our ongoing efforts to ensure the ANB structure is consistent with international best practices. We also are continuing our efforts, with the assistance of USAID, to strengthen banking supervision.
44. While the January 2002 IMF safeguards assessment mission found that the ANB's annual external audit and financial reporting are generally adequate, certain vulnerabilities were identified. To address these issues, the ANB has (i) established a formal process for reconciling the data in the ANB financial statements to the data reported to the IMF under the Poverty Reduction and Growth Facility arrangement, which includes a review of the reconciliation by the ANB's Internal Audit Department, and (ii) formally adopted IAS as its underlying accounting framework in order to base the recording of transactions during the year on IAS requirements. Additional efforts to strengthen ANB auditing and reporting, as recommended by the safeguards mission, are ongoing. The recommendation to establish an audit committee under the ANB's Board of Directors has not been implemented, as the existing law on the Central Bank does not allow such a structure.
Structural Reforms in 2003
Government Operations, Structure and Governance
45. In 2003, we will seek to complete the process of separating commercial and regulatory functions (PRSP, section 4.3). We will, during the course of the year, identify all remaining instances of institutions exercising both commercial and regulatory functions, and separate them. In particular, we will transfer all regulatory functions currently exercised by Azal, Azeri Rail and Caspian Shipping Company to the Ministry of Transport, separate the commercial and regulatory functions of the Ministry of Communications, and transfer remaining regulatory functions from SOCAR to the appropriate government institution.
46. In addition, we will build on the progress we have made in government restructuring in recent years, with the creation of the Ministries of Economic Development, Energy and Transportation. During 2003, with the assistance of the International Financial Institutions, we will review the existing government structure. A decision on possible restructuring will be made based on the results of this review.
47. We will also continue our efforts to improve governance and the business environment. Crucial in this regard will be our ongoing efforts to improve tax and customs administration, as discussed above, as well as to strengthen the Chamber of Accounts, our supreme audit institution. We also expect parliament to pass, during 2003, anti-corruption legislation (PRSP, section 4.3). This legislation is expected to provide a legal definition of corruption, and introduce specific anti-corruption measures.
Energy Sector Financial Discipline
48. Strengthening energy sector financial discipline remains at the heart of our economic reform program (PRSP, section 4.3). Most energy sector quasi-fiscal subsidies have been put on budget, and thus government, parliament and the public are more aware of the true costs of these subsidies. Now we face the more serious challenge of actually reducing these subsidies. This will require a number of reforms: improvements in collections for utilities; increases in the efficiency of SOCAR, the utility companies, and key energy-consuming state-owned enterprises; and eventually a revision of electricity and gas tariffs to cover the true costs of providing these services.
49. Key to our efforts to strengthen financial discipline are steps to improve payments for utility services. We have made great strides in this area, by ensuring that budgetary organizations pay in full for their actual utility consumption, signing long-term management contracts for our electricity distribution companies, and giving these companies the right to cut off services to non-paying customers. Building on these reforms, in 2003 we will aim to sign long-term management contracts for our gas and water distribution companies, and will enhance our efforts to ensure that state-owned enterprises pay their utility bills. We will also seek to initiate the use of "smart cards" for the payment of utility services, to reduce the opportunities for corruption (PRSP, section 4.3).
50. Ensuring that these companies pay their bills in many cases will require a restructuring of their organization and operations. This will be necessary to enhance their efficiency and reduce their energy consumption. In 2003, building on the recent decisions regarding SOCAR restructuring, we will seek the assistance of EBRD in designing a more comprehensive restructuring of that company. We will also seek technical assistance in designing restructuring programs for Azerenergy, Azerigas, Azerbaijan Regional Water Company and Azerchemia.
51. We have requested assistance from the World Bank related to utility tariffs. In particular, we will seek their assistance in reviewing the tariff structure and determining a structure that would eventually cover the costs of providing the services, and in designing a system for compensating vulnerable households from the eventual increase in these tariffs.
52. Finally, having unified domestic prices of natural gas and most oil products with import or export parity, as appropriate, we will now prepare to unify in early 2004 the domestic and estimated long run world market prices for the two remaining oil products—kerosene and diesel fuel—whose prices remain below world market levels, including by designing, in consultation with the World Bank, a mechanism to compensate the most vulnerable who are impacted by these price changes (PRSP, section 3.1). In addition, to ensure that domestic energy prices stay unified with world market prices, by end-December 2003 we will design an automatic mechanism for the periodic adjustment of domestic prices of oil products and natural gas, to keep them in line with world market prices, with that mechanism being implemented in 2004.
Trade and Investment Policy
53. We will continue to implement a liberal trade policy. As noted above, we will gradually reduce our already moderate weighted average import tariff. We will also not introduce any new import or export restrictions. Accession to the World Trade Organization (WTO) is a high priority for our government. We have reached agreement for the United States to provide technical assistance in our WTO accession application and negotiations, and we will make all efforts to expedite this process (PRSP, section 4.3).
54. The government has contracted a diagnostic study of the investment environment by the Foreign Investment Advisory Service (FIAS), a joint IFC-World Bank facility. In consultation with the Fund and World Bank staffs, we intend to revise the 1992 Law on Protection of Foreign Investments (PRSP, section 4.3) along the lines recommended in the FIAS report. Also, to assist potential investors, and to help in conveying information to them regarding our efforts to improve governance and the business environment, as well as to give investors a channel to convey their concerns in this regard to the government, we will create an Investment Council.
55. As prior actions for completion of the second review under the PRGF arrangement, we have (i) submitted to parliament amendments to the Budget Systems Law, designed in consultation with the Fund and World Bank staffs, which call for parliamentary approval of the deficit and expenditure ceilings of the consolidated budget, require that all expenditures in the consolidated budget (except for expenditures on the management of the oil fund and its assets) be executed by the treasury and that all capital expenditures be part of the State Investment Program, assign responsibility for the preparation of the consolidated budget to the Ministry of Finance, ensure that extra-budgetary funds do not make portfolio investments in domestic commercial activities or issue loans or loan guarantees, and require that SOFAZ hold equity positions only through highly rated professional portfolio managers in international markets; (ii) adopted, by presidential decree, the timetables for privatization of IBA and BUS Bank; (iii) adopted procedures for the timely allocation of tax credits to SOCAR and subsidies to Azerenergy and Azergas related to unpaid fuel consumed by the utilities; and (iv) issued a Cabinet of Ministers decree instructing all state-owned enterprises to ensure timely payments of their SPF obligations.
56. We propose the following structural performance criteria for end-June 2003: (i) enactment of the amendments to the budget systems law that were submitted to parliament as a prior action; and (ii) adoption of improved regulations on the issuance of VAT refunds, which simplify work procedures and documentation requirements and specify appropriate timeframes for the processing of refund applications. As structural benchmarks for end-June 2003, we will (i) establish a revenue forecasting commission, as described in paragraph 25 above and in consultation with Fund staff, and (ii) ensure adoption of the new Banking System Law.
57. For end-December 2003, we propose the following structural performance criteria: (i) the reunification of the enterprise profit tax rate for all non-oil companies, at a rate determined in part by our analysis of the 2003 experience; (ii) the adoption of a procedure for future automatic adjustments of domestic energy prices, to keep them in line with world market prices, as discussed in paragraph 52 above; (iii) replacement of specific with ad valorem customs duties in continued adherence to the timetable adopted under the end-March 2002 structural performance criterion; (iv) adoption of a Cabinet of Ministers decision reducing the list of VAT exemptions and requiring that all future changes to the list be done only in the context of the annual budget preparation process; and (v) issuance of a tender for all remaining government shares of IBA. We propose that continued adherence to the SCC reform program, as discussed in paragraph 26, be a structural benchmark for end-December 2003. Finally, the quarterly allocation of tax credits to SOCAR, and subsidies to Azerenergy and Azerigas, in line with the procedures and timetable adopted as a prior action, will be a structural benchmark.
58. The third review of our Poverty Reduction and Growth Facility arrangement will focus on continued progress in energy sector reforms including SOCAR tax payments, banking sector reforms including progress on privatization, and the strengthening of governance in the handling of public resources including in tax and customs administration.
59. The government and the ANB believe that the policies discussed above, combined with the policies described in our previous letters and MEFP, are adequate to achieve the objectives of the program. We will remain in close consultation with the Fund in accordance with Fund policies on such consultation, and will provide the Fund with any information it requests for monitoring program implementation. The government and the ANB stand ready to take any further measures, in consultation with Fund staff, which might be necessary to ensure that the objectives of the program can be achieved.
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PERFORMANCE CRITERIA AND INDICATIVE TARGETS
I. Targets for Fiscal Aggregates
Note: Use of the words "includes" and "including" should be construed to mean "includes but is not limited to" and "including but not limited to".
1. Ceiling on the Cumulative Change of the Overall Cash Deficit of the Consolidated Government, excluding revenue from the oil sector.
(In billions of manats)
The consolidated government is defined as all levels of government except for municipalities and state-owned enterprises. It includes the state budget agencies, (including the Republican government and local governments but excluding municipal governments), extrabudgetary funds of state budget entities, the Social Protection Fund, the Privatization Fund, and the State Oil Fund (SOFAZ).
The overall cash deficit of the consolidated government, excluding
revenues from the oil sector is defined as the overall consolidated
The overall cash deficit of the consolidated government is defined from the financing side as the sum of the following: (i) the change in net credit to the consolidated government from the ANB; (ii) the change in net claims on the consolidated government of the rest of the banking system; (iii) the change in net claims on the consolidated government of domestic nonbank institutions and households; (iv) proceeds from the privatization of state property; (v) the counterparts (-) to increases in net credits or net claims on the consolidated government from the ANB or commercial banks as a result of the bank restructuring program; (vi) net foreign financing of the consolidated government; (vii) the counterparts to changes in the domestic currency valuation of the consolidated government's net credits or net claims as a result exchange rate fluctuations; and (viii) the change in the net position of SOFAZ. All changes will be calculated as the difference between end-period stocks, valued at end-period exchange rates.
SOCAR's cash tax revenue based on budget assumptions is defined as the government's projected tax payments on basis of budget assumptions.
SOCAR cash tax revenue differential on account of oil price movements are additional (reduced) tax revenue payments arising from a higher (lower) actual crude oil price than the budget price. The value of the programmed revenue differential is calculated (i) as the difference between tax obligations arising from the export tax at programmed oil prices, volumes, and export costs and export tax obligations based on 2003 budget assumptions for oil prices and export costs, plus (ii) SOCAR tax obligations arising out of the change in the SOFAZ inflow rules (Presidential Decree, February 7, 2003), if they are due in 2003 plus, (iii) any tax payments that the government makes to reduce SOCAR's arrears to the budget.
Programmed levels of SOCAR tax revenue differential:
SOFAZ revenues are defined as the sum of the following: (i) production sharing revenue from the development of oil fields (profit oil) less of SOCAR's share of production sharing revenue; (ii) acreage fees; (iii) investment income on SOFAZ assets; and (iv) any other revenues deposited in SOFAZ, excluding oil signature bonuses. Production sharing revenues, acreage fees, and investment income of SOFAZ will be considered revenues of the SOFAZ regardless of whether they are actually deposited in SOFAZ or another account of the consolidated government.
Net credit from the ANB to the consolidated government is defined as all claims (including securities) of the ANB on the consolidated government less all deposits of the consolidated government with the ANB, including counterpart deposits of loans received from the World Bank and from other official creditors, proceeds from the privatization of state property.
Net claims on the consolidated government of the rest of the domestic banking system are defined to comprise domestic commercial banks'net asset position arising from the operating balances and current accounts of the consolidated government and domestic commercial banks' net asset position arising from other claims (credits, loans, cash advances, holdings of treasury bills or other securities) on and liabilities (deposits, etc.) to the consolidated government.
The change in net claims on the consolidated government of domestic nonbank institutions and households is defined to include net sales of treasury bills, bonds, or other government securities to nonbank institutions and households, plus any other increase in liabilities of the consolidated government to domestic nonbank institutions or households.
Proceeds from the privatization of state property are defined as all gross revenues originating from the sale or long-term leasing of state property.
Counterparts to increases in net claims on the consolidated government of the ANB or commercial banks as a result of the bank restructuring consist in the full value of the loans taken over or long-term bonds issued by the consolidated government.
Net foreign financing of the consolidated government is defined as the difference between actual disbursements of foreign financing and amortization of consolidated government debt to foreign institutions and households. Foreign financing of the consolidated government is defined as the increase in claims on the consolidated government of foreign institutions and households, excluding the Fund, and including: (i) loans received for balance of payment support (e.g. the World Bank Public Sector Reform Adjustment Credit); (ii) disbursements under foreign loans for financing government capital expenditures or for on-lending to entities outside the general government for investment projects from foreign financial and nonfinancial institutions; (iii) oil signature bonuses; and (iv) net purchases of government securities by foreign (nonresident) institutions and households. Consolidated government guarantees on loans to entities outside the consolidated government are not included as foreign financing, and payments made by the consolidated government to cover defaults on such loans are not included as amortization of consolidated government debt.
The change in SOFAZ's net position is the difference between SOFAZ revenues and expenditures.
The general government is defined as the consolidated government excluding the SOFAZ.
Ceilings will be adjusted by the full amount of any deviation from the programmed level of the actual financing for the BTC pipeline project plus actual foreign financing of capital projects and foreign loans contracted by the consolidated government for on-lending purposes. A shortfall of financing will result in a downward adjustment of the ceiling. Higher-than-programmed financing will result in an upward adjustment. Cumulative programmed financing is manat 437 billion Q1, manat 801 billion Q2, manat 1,054 billion Q3, manat 1,307 billion Q4.
Ceilings will be adjusted downward by 50 percent of any shortfall in the programmed disbursements of World Bank loans for balance of payments support (e.g. the Public Sector Reform Adjustment Credit). Cumulative programmed disbursements are manat 0 billion Q1 (indicative), manat 0 billion Q2, manat 151 billion Q3, manat 151 billion Q4.
2. Indicative Target: Ceiling on the Stock of Unpaid Bills of the State Budget and the Social Protection Fund accumulated after December 31, 2002
(In billions of manats)
The ceiling applies to all unpaid bills of the state budget and the Social Protection Fund accumulated after December 31, 2002 (in excess of manat 50 billion). Arrears are defined as expenditures that have been budgeted for, have been verified (the good or the bill has arrived), and have not been paid. Expenditure arrears include all arrears except pension arrears to working pensioners.
3. Ceilings on the Stock of Net Credit from the ANB to the General Government
(In billions of manats)
These limits will be adjusted downward (or upward) by 50 percent of the amount by which actual net foreign financing of the general government exceeds (or falls short of) the net amounts programmed from the following sources: (i) the amortization of general government debt to foreign institutions and households, based on the stock of foreign debt outstanding as of December 31, 2002, including loans for budgetary or on-lending purposes, but excluding payments to the Fund and payments on government guaranteed loans to cover defaults by entities outside the general government. Ceilings will be adjusted upwards by 50 percent for any shortfalls of disbursements of World Bank loans for balance of payments support (e.g. the Structural Adjustment Credit), irrespective of their deposit at the ANB or elsewhere and adjusted downwards by 100 percent for disbursements in excess of programmed levels. The ceiling will be adjusted downward (or upward) in the amount by which the programmed SOCAR revenue differential on account of oil price movements fall short (exceed) of the actual SOCAR revenue differential.
Cumulative net foreign financing from these sources is programmed to be manat -29 billion at end-2003 Q1, manat -47 billion at end-Q2, manat 74 billion at end-Q3, manat 53 billion at end-Q4.
Net credit from the ANB to the general government is defined as all claims (including securities, but excluding all bonds issued in 2001 by the government in settlement of ANB's claims on Agroprom) of the ANB on the general government less all deposits of the general government with the ANB, including counterpart deposits of loans received from the World Bank and from other official creditors, and proceeds from the privatization of state property. As indicated above, the general government is defined as the consolidated government excluding the SOFAZ. Net Credit to Government will also include any claims of the ANB on the general government related to accounts currently under review by the staff and authorities.
II. Targets for Money Aggregates
1. Ceilings on the Stock of Net Domestic Assets of the ANB
(In billions of manats)
The ceilings relative to programmed amounts will be adjusted in exactly the same manner as the ceilings for net credit from the ANB to general government.
Net domestic assets of the ANB are defined as: (i) reserve money (comprising currency in circulation, required reserves, and balances on banks correspondent accounts at the ANB) plus certificates issued by the ANB plus deposits of nongovernment nonbanks with the ANB minus; (ii) net international reserves in convertible currencies of the ANB (as defined in II.2 below) plus net assets on the ANB's correspondent accounts with central banks in nonconvertible currencies. Thus defined, the ANB's net domestic assets consist of ANB net credit to the consolidated government (including counterpart deposits)1, claims on domestic banks, claims on domestic enterprises and households, and other net assets.
2. Floors Under the Stocks of Net International Reserves of the ANB
(In billions of manats)
The ceilings relative to programmed amounts will be adjusted in exactly the same manner as the ceilings for net credit from the ANB to general government.
Total net international reserves of the ANB are defined as the difference between total gross international reserves assets of the ANB and total official reserve liabilities of the ANB. Gross international reserve assets are defined as in the Balance of Payments Manual, 5th edition. Total Gross international reserve assets of the ANB include ANB's holdings of monetary gold, holdings of SDRs, any reserve position in the Fund, holdings of foreign exchange in convertible currencies in the form of cash or deposits with nonresident banks that are readily available. Also included are holdings of foreign currency—denominated securities issued by governments or central banks of OECD member states. Excluded are capital subscriptions in international financial institutions, non-liquid assets of the ANB (beyond one year to maturity), as well as pledged or encumbered assets and claims on residents. Official gold holdings shall be valued at US$ per troy ounce. Holdings of SDRs and other reserve position in the Fund will be valued at a constant exchange rate of SDR 1: manat 5,804. Other reserve balances will be valued at a constant exchange rate of US$1:manat 4,606. Gross international reserve assets exclude the ANB's net forward position, defined as the difference between the face value of foreign currency denominated ANB off balance sheet claims on nonresidents and foreign currency obligations to both residents and nonresidents. Official reserve liabilities of the ANB are defined as outstanding Fund purchases, and liabilities of the ANB to nonresidents with an original maturity of up to and including one year. Reserve liabilities to the Fund will be valued at a constant exchange rate of SDR 1: manat 5,804. Other reserves will be valued at a constant exchange rate of US$1: manat 4,606.
3. Indicative Limits on the Stock of Manat Reserve Money of the ANB
(In billions of manats)
Manat reserve money of the ANB is defined as the sum of currency issue, required reserves in manats, balances on commercial banks' correspondent accounts with the ANB and other manat liabilities of the ANB to domestic banks.
III. Ceilings on External Debt and External Payments Arrears
New Nonconcessional External Debt Contracted or Guaranteed by the Consolidated Government or the ANB (excluding the Fund)
(In millions of U.S. dollars)
Maturity of one to less than five years:
Maturity of five years or more loans:
Nonconcessional external debt with original maturity of at least one year, contracted or guaranteed by the consolidated government or the ANB, excluding the Fund.
This performance criterion applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), August 24, 2000) but also to commitments contracted or guaranteed for which value has not been received. The definition of debt set forth in No. 9 of the guidelines reads as follows: "(a) For the purpose of this guideline, the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property. (b) Under the definition of debt set out in point 9(a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt."
Debt rescheduling and restructuring are excluded from the borrowing limits. In determining the level of concessionality of these obligations, the definition of concessional borrowing shall apply. Concessional borrowing is defined as having a grant element of 35 percent or more. For loans with a maturity of at least 15 years, the 10-year average commercial interest reference rates (CIIRRs) published by the OECD should be used as the discount rate for assessing the level of concessionality, while the 6-month average CIRRs should be used for loans with shorter maturities. To both the 10-year and the 6-month averages, the following margins for differing repayment periods should be added: 0.75 percent for repayment periods of less than 15 years; 1 percent for 15-19 years; 1.15 percent for 20-29 years; and 1.25 percent for 30 years or more.
Stock of Short-term External Debt, Contracted or Guaranteed
by the Consolidated Government2 or the ANB
Short-term external debt is defined as debt contracted or guaranteed by the consolidated government or the ANB with contractual maturity of less than one year, excluding normal import-related credits.
Outstanding Nonreschedulable External Payments Arrears
The stock of nonreschedulable external payments arrears is defined as the external debt service obligations (principal and interest) of the consolidated government3 and the ANB, including for government guaranteed loans, to multilateral and bilateral creditors, that have not been paid at the time they are due, excluding arrears on external debt service obligations pending the conclusion of debt rescheduling operations.
1 For a definition of consolidated government, see Section I.1.
2 For a definition of consolidated government, see Section I.1.
3 For a definition of consolidated government, see Section I.1.