June 6, 2000

Dear Mr. Köhler:

1.  This letter is to update you on our progress in implementing the prior actions for completion of the first review under the stand-by arrangement; recent macroeconomic developments; and policy measures to address recent developments in the financial system.

I. Prior Actions

2.   The prior actions included in our Memorandum on Economic Policies of May 16, 2000, have been undertaken: (a) written expressions of interest concerning Banca Agricolã were received from potential investors before the deadline of May 19, and we are proceedingwith the agreed timeline for the bank’s privatization program; (b)Emergency Ordinance 67/1999 was abrogated on May 14, 2000; and (c) Emergency Ordinance 98/1999, granting a severance pay entitlement across the economy, was amended on May 30, 2000, so as to abolish the entitlement for any new claimants, except in cases where such payments are co-financed by donors. Moreover, Emergency Ordinance 58/2000—encompassing measures to strengthen financial and wage discipline in régies autonomes, commercial companies, national companies and certain commercial companies with majority state capital in the year 2000—was enacted on May 24, 2000;

II. Macroeconomic Developments

3.   Romania’s external adjustment retains strong momentum: the cumulative current account for the first quarter of 2000 shows a deficit of only US$38 million, achieved on the basis of an export growth of 26.9 percent and of an increase in imports of 14.5 percent over the corresponding period of 1999. At the same time, preliminary figures for the trade balance indicate a deficit of US$79 million over January-April 2000, representing only 20.5percent of the corresponding balance for 1999, with exports and imports growing by 28.4 percent and 14.3 percent respectively over the similar period of the previous year.

4.   Monetary developments are also on track, and NFA and NDA figures for April are consistent with the January-June program path for these aggregates.

5.   As concerns our fiscal program, the consolidated budget deficit in January-April 2000 is estimated at ROL 6,751.6 billion or 0.9 percent of annual GDP. In light of recent media reports, we would also like to reiterate that the Government of Romania will not consider new measures to reduce taxation, including VAT rates. Similarly, the envisaged abolition of earmarked revenue for special funds will proceed within the agreed fiscal deficit target, as such fund expenditures will be ceased or financed through new revenue measures.

III. Recent Financial Sector Developments

6.   In the last week of May, Romania has witnessed the failure of the country’s largest investment fund, FNI. A preliminary assessment, based on the work of experts and legal authorities, indicates that this failure reflects gross mismanagement and fraudulent practices, as well as poor regulatory oversight. We have estimated that the real assets represent only a small fraction of the declared inflated value of the assets. The failure of the fund also involved the state-owned Savings Bank (CEC) concerning the following aspects:

• The direct participation of CEC in the management company of the FNI (SOV Invest);

• The direct investment of CEC in FNI certificates of ROL290 billion, during April-July 1999;

• A fraudulently extended and legally invalid guarantee for FNI investment certificates; and

• The sales of FNI certificates through branches of a CEC subsidiary.

7.   The financial difficulties of FNI, amplified by baseless rumors concerning the financial situation of the Romania Commercial Bank (BCR), contributed to public concern over the safety of the financial system and we had to act swiftly to contain the potential fallout of the fund’s failure. By swiftly meeting fairly sizable cash withdrawals of deposits, BCR was able to calm the situation in a very short period of time. The NBR was able to ensure smooth logistics for continuing cash payment throughout the country and to limit the injection of supplementary liquidity. Subsequently, investor concern shifted to the nonbank financial sector and, on June5, the Romanian Popular Bank—despite its name, a credit cooperative that was not subject to any type of financial supervision—closed its operations after being unable to meet demands for deposit withdrawals. The Romanian Popular Bank was by far the largest credit cooperative with total assets estimated at about lei 800 billion at end-March 2000. Meanwhile, the domestic money and foreign exchange markets have remained calm. The exchange rate posted by exchange bureaux (which play a marginal role on the market), after peaking at above 25,000 ROL/USD for one day, returned to a level compatible with the monetary program, below 21,000 ROL/USD. The interest rate on the interbank market remained stable at around 35 percent overnight, reflecting continued confidence in the banking system.

8.   As a first principle, we will not spend any public funds to compensate FNI investors. Strong messages released by the Government through the mass media have emphasized the differences between units in investment funds and bank deposits and the absence of any state guarantee for investment funds. At the same time, the Government is acting towards restoring the credibility of the non-bank financial sector, including the preservation of value of the remaining assets of FNI and SOV Invest. As immediate measures, we have already taken the following steps:

• Imposed a complete freeze on all transactions and activities of the FNI and SOV Invest.

• Safeguarded critical data and documents. Specifically, state legal authorities have moved to secure and seize all accounting documents, all computerized files and their back-up, correspondence, and Board minutes of FNI and SOV Invest. In SOV Invest, this comprised a quarantine/sealing-off of all offices from past and present officers so as to forestall any evidence tampering. In CEC (and its subsidiaries), this included all related correspondence, minutes, and original accounting vouchers supporting transactions of any kind with FNI and SOV Invest.

9.   Meanwhile, we have initiated a comprehensive set of investigations with a view to moving expeditiously toward legal proceedings against the responsible individuals and entities, including:

• Investigation of the size of the losses for FNI investors, based on the amount and date of their initial investment, and analysis of the flow of funds, including in particular subscriptions and redemption of investment units, which will make it possible to understand how the FNI scheme worked and who its main beneficiaries were. This work is to be completed by June 15, 2000.

• Investigation of the factors that prevented the early detection of the FNI scheme, to be completed by end-June, 2000. This would include, inter alia, determining the likely date at which the inflated and fraudulent reporting of the assets began; the role of the CNVM and reasons for the absence of any reaction; the 1998 sale of SOV Invest; the role of FNI auditors and circumstances of their certification that the financial statements complied with all applicable rules and regulations; and the role of any other party which might or should have known about the FNI scheme.

• Investigation of the conduct of the CEC in the FNI scheme, to be completed by end-June, 2000. This would focus in particular on CEC behavior as shareholder, investor, and provider of services through its subsidiary (subscription of shares, redemption, marketing), as well as on the background of the guarantee contract signed by the former President of the CEC.

• Imposing control of personal assets of individual and corporate entities who were responsible for the FNI scheme and of individuals who made significant gains out of the FNI scheme during the suspicious period.

10.   These investigations should eventually lead to legal proceedings against, and prosecution of, individuals and entities who broke civil and commercial laws and of individuals who broke criminal laws. Meanwhile, on the basis of an emergency ordinance, we have already revoked the current Commissioners and Chairman of the CNVM and, in their places, have appointed an interim management consisting of experts from relevant public institutions. We have also removed the current Board and the management team, including the President, of the CEC and replaced them with individuals that meet the requirements specified in existing laws and NBR regulations. Moreover, all individuals previously involved in FNI and SOV Invest have been removed from positions that could allow them to access and/or dispose of FNI/SOV Invest assets and documents.

11.   Moreover, with World Bank expert assistance that is to commence in mid-June, we will seek to address structural weaknesses in the regulation and supervision of non-bank financial institutions in Romania and prevent the recurrence of similar problems. Specifically, within three months, we intend to agree with the World Bank on the diagnosis of the legal and regulatory framework of financial intermediation in Romania, including that for credit cooperatives, and initiate the implementation of an action plan based on the outcome of this diagnosis, including but not limited to:

• An in-depth study of the financial position and the legality of the activities of other mutual funds (and the banking system’s exposure) so as to uncover any additional instances of inflated net asset positions and valuations.

• An in-depth study of the legal and regulatory environment, including the division of responsibilities between the NBR and the CNVM.

• An enhancement of the supervisory role and effectiveness of the CNVM—by clarifying its rules of conduct, making it more accountable in line with international practice, and defining applicable emergency measures in the event its effectiveness is curtailed.

• Introduction of a proper supervisory and regulatory framework for credit cooperatives or so-called popular banks as soon as possible, and not later than end-June 2000.

• Assessment of the legal status of all investment funds, including those operating in foreign exchange.

• Strengthening of banking supervision in the area of banks’ investment in non-banking financial institutions.

12.   As a means of addressing corporate governance problems in the CEC, the Government will, as a first step, engage an accounting/audit firm by end-June to perform a management audit, an operational audit, and a financial audit of the bank based on International Accounting Standards (IAS). Following these measures, broader reform of the CEC, including its status, will be undertaken in cooperation with the World Bank.