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

April 26, 2001

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

Dear Mr. Köhler:

We are committed to moving ahead with an ambitious and far-reaching macroeconomic and structural reform program in the 2001-2003 period, which will build upon past reform efforts that have been financially supported by the IMF and the World Bank since 1994. Following the decline in output in the early 1990s, significant progress was made on macroeconomic stability and restoration of growth under the government's economic reform program during 1996-1999, supported by arrangements under the IMF's Enhanced Structural Adjustment Facility (ESAF) and by considerable World Bank assistance. At the same time, and despite the economic growth performance during this period, there has been very little progress in reducing poverty and income inequality, as reflected in the Interim Poverty Reduction Strategy Paper (IPRSP).

The Armenian economy weakened following the political assassinations in October 1999. The resulting political uncertainty led to a very significant deterioration in the fiscal position and a temporary slowdown in the real economy which only began to be reversed as the political situation stabilized in the course of 2000. In the fiscal area, there was a very substantial and rapid run-up in budgetary expenditure arrears beginning in the fourth quarter of 1999, reflecting the effects of the political situation on external financing and tax receipts. The government has already taken measures to improve tax revenues and there are clear signs of a revenue recovery starting in June 2000. In the real sector, the economy contracted in the fourth quarter of 1999 but real GDP began to recover starting in the second quarter of 2000, and growth accelerated in the remainder of 2000, despite a summer drought affecting a portion of agriculture.

The attached Memorandum of Economic and Financial Policies outlines our key macroeconomic objectives and policies for 2001 to 2003, which are designed to address these challenges, and objectives and policies for the first year of the program. At the center of the program is a sizeable fiscal adjustment that will be supported by structural reforms, in particular efforts to improve tax administration and expenditure control, and to improve governance. The memorandum also describes our initiatives to strengthen the banking system. The IPRSP, which was prepared by the government after extensive discussions with representatives of civil society and international institutions, lays out our broader structural reform efforts aimed at poverty reduction and economic growth.

In support of our economic adjustment and reform program, Armenia requests a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) in an amount equivalent to SDR 69 million (75 percent of quota).

We are confident that the policies and measures described in the attached memorandum are adequate to achieve the objectives of the program. However, the government and the Central Bank of Armenia stand ready to take any other measures that may become appropriate for this purpose. In the period of the PRGF arrangement, the government and the Central Bank of Armenia will regularly consult with the IMF concerning additional measures that may become appropriate and will provide the IMF with such information as the IMF requests in connection with the progress of Armenia in implementing the policies and reaching the objectives of the program supported by the PRGF arrangement.

After the period of the arrangement, and while Armenia has outstanding financial obligations to the IMF from loans and earlier arrangements, the government will consult with the IMF on Armenia's economic and financial policies from time to time, at the initiative of the government or at the request of the Managing Director. Armenia will conduct with the IMF the first semi-annual review of its program before September 30, 2001, as described in the attached memorandum.

Republic of Armenia
Memorandum of Economic and Financial Policies for 2001-2003

I. Introduction

1. We are committed to moving ahead with an ambitious and far-reaching macroeconomic and structural reform program in the 2001-2003 period, which will build upon past reform efforts that have been financially supported by the IMF and the World Bank since 1994. Following the decline in output in the early 1990s, significant progress was made on macroeconomic stability and restoration of growth under the government's economic reform program during 1996-1999, supported by arrangements under the IMF's Enhanced Structural Adjustment Facility (ESAF) and by considerable World Bank assistance. Period average CPI inflation declined from 175 percent in 1995, prior to the start of the ESAF, to 0.7 percent in 1999. Real growth, driven by construction and services, averaged around 5 percent over the program period, despite the effects of a drought and the impact of the Russian economic crisis. At the same time, however, despite the economic growth performance during this period, there has been very little progress in reducing poverty and income inequality, as reflected in the Interim Poverty Reduction Strategy Paper (IPRSP).

2. Non-inflationary monetary and fiscal policies contributed to this strong macroeconomic performance. The non-inflationary fiscal stance was facilitated by abundant official external financing. Inflation remained low in 1998-1999, even though program projections for broad money growth were exceeded in almost every quarter since late 1996, as money demand continued to respond more strongly than anticipated to the stabilization policies pursued. Nevertheless, there was a worrisome lack of progress in increasing exports, which contributed to the very rapid growth in external debt ratios (the external debt/export ratio increased from 127 percent at end-1995 to 223 percent at end-1999). In addition, real interest rates remained high, and there were frequent budgetary revenue shortfalls and problems with expenditure control.

3. Substantial progress was made in structural reforms during the period of the ESAF arrangements. Progress was achieved on banking system reform, establishment of a treasury, strengthening of the social safety net, and revising tax laws. Considerable reforms were also carried out in the quasi-fiscal sectors (including the energy, irrigation, and drinking water and sewage sectors)—improving collections and production efficiency, beginning the process of eliminating the culture of non-payment, improving the transparency of and budgeting for quasi-fiscal energy subsidies, and initiating the privatization of the sector.

4. The Armenian economy weakened following the political assassinations in October 1999. The resulting political uncertainty led to a very significant deterioration in the fiscal position and a temporary slowdown in the real economy which only began to be reversed as the political situation stabilized in the course of 2000. In the fiscal area, there was a very substantial and rapid run-up in budgetary expenditure arrears beginning in the fourth quarter of 1999, reflecting the effects of an unstable political situation on external financing and tax receipts. The government has already taken measures to improve tax revenues and there are clear signs of a revenue recovery starting in June 2000. In the real sector, the economy contracted in the fourth quarter of 1999 but real GDP began to recover starting in the second quarter of 2000, and growth accelerated in the remainder of 2000, despite a summer drought affecting a portion of agriculture. Although consumer prices rose by almost 3½ percent in the last two months of the year, cumulative inflation for 2000 as a whole was only 0.4 percent.

II. The Medium-Term Strategy

5. To address Armenia's remaining external and fiscal vulnerabilities, and to ensure a sustained resumption of economic growth as the cornerstone for efforts to reduce poverty, the government and the Central Bank of Armenia (CBA) have adopted a comprehensive and ambitious macroeconomic and structural adjustment program for the period January 2001-December 2003. Under this program, developed in collaboration with the staffs of the IMF and the World Bank, we intend to strengthen public finances to eliminate the outstanding stock of budgetary arrears, maintain a rate of monetary growth consistent with continued price stability, progressively eliminate financing gaps in the quasi-fiscal sectors, further improve regulation of the banking sector, and improve governance through increased transparency and reduced corruption. The envisaged reforms are consistent with the IPRSP, which sets out the main elements of the broader program aimed at achieving sustained, rapid growth and poverty reduction. The program will be modified appropriately once the Poverty Reduction Strategy Paper (PRSP) has been finalized.

Macroeconomic Objectives and Policies

6. Our medium-term strategy will be to implement appropriate monetary and fiscal policies, as well as structural reform and governance measures, in order to enhance Armenia's growth prospects. Macroeconomic policies will need to focus initially on raising budgetary revenues and clearing arrears, and on reducing the fiscal deficit gradually over time, while pursuing a monetary policy consistent with price stability. Major initiatives to implement structural reforms and strengthen governance will be essential for improving the overall business environment, encouraging more investment (including foreign direct investment), and stimulating export growth. These policies should also help reduce the external debt burden over time.

7. Armenia's growth is projected to average around 6 percent per annum during 2001-2003 and be broadly based, while annual inflation should be held to about 3 percent. Fiscal policy under the program will focus on a gradual decline in the deficit which would be in line with the need to slow the growth of Armenia's external debt. On the basis of present commitments of external financing, the fiscal deficit (accrual basis) is currently projected to decline, from about 6½ percent of GDP in 2000, to 3 percent in 2003. This deficit reduction, combined with net private investment that is around 7½-8 percent in both 2000 and 2003, would make possible a reduction of the current account deficit from 14½ percent in 2000 to 10½ percent in 2003.

Fiscal Policy

8. Fiscal policy will focus on: (i) gradually reducing the deficit and eliminating the stock of arrears; (ii) maintaining an appropriate balance between current and capital expenditures while reducing non-productive expenditure; (iii) rationalization of social expenditures and possibly increasing them; and (iv) achieving ambitious but realistic tax revenue targets.

9. Reliance on external financing is expected to decline over the program period, and it is our intention to avoid contracting any new non-concessional external debt obligations. We intend to continue our efforts to improve coordination of monetary and fiscal policies and the functioning of the treasury bill market, which should lead to a decline in interest rates on treasury bills over the medium term. In view of the modest stock of domestic debt, there may be some scope for increasing reliance on the issuance of government securities, although the scope for such financing is limited given the need to avoid crowding out of the private sector. The prohibition on net inter-quarter direct financing of the budget by the CBA has proven to be useful in contributing to macroeconomic stabilization, and it will continue.

10. Strengthening of tax collections will come largely from improved tax and customs administration, and through improved governance including increased transparency and reduced corruption. The government has already achieved progress in the reform of the tax system, in particular, the abolition of nuisance excise taxes, broadening the tax base (removal of exemptions under the VAT, personal and corporate income taxes, and mandatory social insurance contributions), and rationalization of tax rates. Additional measures will include the elimination of remaining tax exemptions and the unification of widely varying excise taxes on similar products, which currently provide opportunities for tax evasion or avoidance. Over the program period, as the administrative capacity for VAT refunds improves and interest rates decline, we will make every effort to extend collection of the VAT to the border for all eligible goods.

11. Improving expenditure efficiency will require a number of steps, including to: (i) improve and consolidate development of the treasury system; (ii) improve the internal audit function of the Ministry of Finance and Economy (MFE) and the line ministries; (iii) strengthen the government's capacity to assess potential public investment projects; (iv) improve the management of state debt (including both external and domestic debt); and (v) refine the Medium Term Expenditure Framework (MTEF) and integrate it into future budget preparations. The key goal of expenditure control will be the prevention of new expenditure arrears. To this end, we intend to implement measures to improve the procedures for recording and timely monitoring of expenditure arrears of the general government.

12. A key element of the MTEF will be the prudent utilization of privatization proceeds. Any expenditure financed by privatization proceeds will be done in the context of the medium term strategy that was prepared prior to the submission of the 2000 budget. We intend to review this strategy periodically as needed, in consultation with the IMF and World Bank staff, especially in connection with the annual budget submissions to the parliament. In reviewing such plans, explicit consideration will be given to identifying ways in which these funds would assist in the program to reduce poverty. We shall continue to follow the principle that the bulk of proceeds in the Special Privatization Account (SPA) should be used for well thought out capital expenditures (one-off revenue should not be used to finance current expenditure) and the retirement of non-concessional external debt (given the high external debt burden). Any reduction in the present value of the stock of non-concessional external debt arising from debt rescheduling agreements could be used to reduce the amount to be devoted for the retirement of such debt. We will consult with the World Bank staff regarding the list of capital projects to be financed using SPA proceeds.

13. We are currently negotiating a possible restructuring of Armenia's debt to Russia (part of which is in arrears), and we remain hopeful that the prospective agreement with Russia—which might take the form of a debt/equity swap—will lead to a substantial reduction in the present value of Armenia's external debt. The government will submit to the parliament draft amendments to the 2001 budget law which will enable the government to repay external arrears to Russia by drawing down the SPA.

14. The nuclear power plant may soon need to finance the purchase of additional fuels and other necessary inputs. This purchase will be made either by drawing on an existing line of credit from Russia, for which the available balance is $11.6 million, or by the government contracting or guaranteeing the contracting of a new non-concessional loan instead of drawing on the existing line of credit. Should the latter approach be followed, the government will not subsequently draw down the credit line's available balance and will—in the context of any debt restructuring agreement with Russia—request that the credit line be closed.

Monetary, Exchange Rate, and Trade Policies

15. Building on its success in maintaining low inflation during 1998-2000, the main objective of the CBA will be to implement a monetary policy consistent with its obligation under the law to maintain price stability. This objective will be accomplished through adherence to an indicative reserve money corridor, which will serve as the nominal anchor for monetary policy. The CBA will continue to maintain a flexible exchange rate policy and will only intervene in the foreign exchange market to smooth short-term exchange rate fluctuations. Given the CBA 's reluctance to allow the exchange rate immediately to adjust fully to exchange market pressures, movements of reserve money toward the edges of the corridor will provide the CBA with a signal of the need to reassess its short-term credit and foreign exchange market policies. In the event that reserve money moves outside the corridor, the CBA will consult promptly with the IMF staff regarding the appropriate policy response.

16. The government will continue to coordinate closely with the CBA in order to smooth budgetary expenditures as much as possible in the event of bulky inflows of official external financing, or short-term bridging operations—which would only take place under extraordinary circumstances—involving the SPA. Any bridging operation would be coordinated in such a way between the MFE and the CBA that the reserve money corridor would not be breached. In this connection, and in light of the delay in the first disbursement under the SAC IV by several weeks, we have decided to borrow up to dram 5 billion from the SPA temporarily, which will be repaid on receipt of the first SAC IV disbursement. Moreover, we recognize that continued independence of the CBA is essential for ensuring that monetary policy is conducted in a manner that is consistent with price stability.

17. Armenia maintains a liberal trading system with no nontariff barriers (for trade protection purposes) and no export taxes. Most imports enter the country duty-free, while goods subject to import duties are assessed a uniform 10 percent import duty. The payments system is also very liberal with no current account restrictions and only a few minor capital account restrictions (most of which are imposed for prudential reasons). The government will maintain this liberal trade and payments system, which has served Armenia well, and strive to integrate further the Armenian economy into the world economy. In the very near future the government expects to adopt the remaining regulatory and legal requirements for WTO admission with the hope of completing Armenia's accession to the WTO in 2001. Furthermore, the government will redouble its efforts to attract foreign direct investment through a strengthened public relations campaign abroad and an improved business environment at home.

18. During the period of the program, we will not: (i) impose or intensify restrictions on payments or transfers for current international transactions; (ii) introduce multiple currency practices; (iii) conclude bilateral payments agreements that are inconsistent with Article VIII of the IMF's Articles; or (iv) impose or intensify import restrictions for balance of payments reasons.

Balance of Payments and External Financing

19. The trade balance deficit (goods and services) is expected to narrow significantly from 27 percent of GDP in 2000 to 20½ percent of GDP in 2003 as exports will benefit from buoyant foreign direct investments into the diamond cutting, base metal, and tourism industries, while import demand is expected to remain subdued as new enterprises emerge and newly privatized industries improve business practices and gain a higher share of the domestic market. Part of the lower trade balance deficit is expected to be offset by higher outflows of profit remittances and lower official transfers; nevertheless, the external current account deficit is programmed to narrow by about 4 percentage points of GDP (in line with a targeted increase in public sector savings of a similar magnitude) to around 10½ percent of GDP by 2003. Over the program period, foreign direct investments are expected to provide the bulk of external financing as the government—cognizant of the need to limit the further build up of external indebtedness—will target net external budgetary financing of nearly 2½ percent of GDP in 2003, down from nearly 4½ percent in 2001, but somewhat higher than the figure of 1½ percent in 2000.

Quasi-fiscal Sectors

20. We intend to implement a reform strategy designed to eliminate the culture of non-payment, particularly in the quasi-fiscal sectors (defined as energy, irrigation, water and sewage companies, district heating, and the Nairit chemical company). To complete the task of improving the viability of the quasi-fiscal sectors, it will be essential to take further measures, to be designed in consultation with the World Bank staff, to make these sectors progressively more self-reliant, through reduced losses, improved revenues, and if necessary higher tariffs. By the end of the program period, we are committed to either eliminating the financial gaps of these sectors or covering any remaining financial gaps by budget support.

21. In the energy sector, privatization of the energy distribution companies (EDCs) to internationally reputable companies on the basis of competitive tenders will be essential to promote the efficient and least cost operation of the companies. In addition, we intend to strengthen the legal and regulatory framework; promote the successful development of competitive electricity markets; and attract private investment in the non-privatized parts of the power sector. We intend to attain full cost-recovery operation in the electricity transmission sector; ensure continuous assessment of the financial condition of the borrowing entities; and set financial performance targets to help achieve financial viability of the sector.

22. It will also be important to improve the financial performance of the other quasi-fiscal sectors, especially since a part of the financial difficulties of the energy sector are due to non-payment of energy bills by the other quasi-fiscal sectors. In the irrigation sector, we aim to reduce energy usage in irrigation pumping stations and gradually increase tariffs. For Yerevan Water and Sewage Company, we have already recruited an international water operator to manage the company under a four year performance contract. Measures to be taken by the operator under the management contract are extensive, and will provide incentives for improved performance. For Armenia Water and Sewage Company, we intend to ensure that reforms do not affect access of the poor to high quality water; improve the company's cash flow through the reform of billing and collection; and further improve the company's accounting practices. We also intend to promote a new water sector law modeled on the electricity and telecommunications laws, clarifying rights and obligations of all sector stakeholders and ensuring clear and predictable "rules of the game." For district heating, we intend to develop the legal framework and assess a wide spectrum of economically and socially feasible heating options in Armenia, with a view to eliminating the fiscal deficit arising from district heating. In 2001, in pursuit of these objectives we are committed to develop an urban heating strategy with assistance from the World Bank. Moreover, we intend to treat the Nairit company as a commercial enterprise, which must be viable to remain in operation.

23. The accumulated debts of these sectors to the energy sector, and the corresponding debts of the energy sector to others, are a reflection of inadequate tariffs and administrative policies which discouraged financial discipline and in some cases encouraged theft. We will ensure that these debts are rescheduled on commercial terms.

24. Privatization is an essential step for ensuring the financial viability of the energy sector and to avoid a further debt build up. The gas distribution network is already largely privatized and, as elaborated further below, the electricity distribution network will be privatized in early 2001. Following the successful privatization of the EDCs, we intend to work out a strategy for restructuring energy sector debt with World Bank assistance. We aim to move ahead with the privatization of other elements of the energy sector, in a fully transparent manner, during the program period.

Structural Reforms and Governance

25. In addition to the structural fiscal and quasi-fiscal reforms described previously, progress in a number of structural areas will be critical to the success of our reform program. This will include significant progress in completing the privatization process; measures to reduce corruption and improve the quality and transparency of governance (in particular, strengthening the external audit between the different bodies of the Republic of Armenia); legal, judicial, and institutional reforms; and banking sector reforms. These efforts will be supported by the World Bank. The government has established a working group that is currently preparing a framework to define government functions. This includes an analysis of the appropriate choice of government responsibilities consistent with the government's capacities as well as questions of decentralization and delegation of authority.

26. We intend to enhance the financial monitoring of state-owned enterprises, including through publishing quarterly reports about their financial operations, and complete the privatization program in the next few years. We intend to privatize those remaining state-owned enterprises that can be sold, while moving quickly to make final decisions about how to handle companies that cannot be sold regardless of price. In view of the non-payments problem in the private sector, we intend to put a high priority on improving bankruptcy procedures (the application of which would lead either to the rehabilitation or liquidation of an enterprise). In this regard, we intend to advance the reform of the judicial system, in consultation with the World Bank staff, to ensure that it is adequate to support a market-oriented economy, as well as to enhance the capacity to implement bankruptcy procedures.

27. Strengthening of public sector institutions, in particular implementing civil service reform, will be a key part of our efforts to improve governance and reduce corruption. In this regard, we have asked the international community to assist us in developing a strategy for combating corruption. This strategy will focus on prevention, enforcement, and public education and information. We intend to continue past efforts to increase public awareness of the utilization of grants by requiring detailed reports, to the parliament and the public, and we intend in the future to require similar detailed reports on the outcome of privatization efforts.

28. Further efforts to enhance the ability of the CBA to supervise the banking system are important since a more efficient system of financial intermediation, with greater public confidence in commercial banks, will be an integral component of the strategy to increase domestic saving and investment. Restructuring and privatization of the Savings Bank, the only remaining state-owned bank, in consultation with the World Bank staff, will be a key step in the process of restructuring the banking sector. It will also be important to maintain the current practice of government noninterference with the operations of commercial banks or the enforcement by the CBA of prudential regulations. We will continue to review the procedures for enforcing these regulations, to see if further strengthening is needed, and continue to strengthen banking supervision. The CBA intends to increase minimum capital requirements progressively for existing banks to the same level as new banks ($5 million) by mid-2005. Finally, we will take steps to strengthen the powers of the CBA in bank bankruptcy and reorganization cases. Our efforts to strengthen the banking sector will be guided by the recommendations of the recent joint IMF/World Bank Financial Sector Assessment Program (FSAP) mission.

Poverty Reduction

29. Central to the new program will be a major effort to reduce poverty. As described in the IPRSP, the key to poverty alleviation, and to reversing the pattern of increasing income inequality, will be economic growth, because without such growth Armenia will not have the resources to reduce poverty significantly. Accordingly, one component of our anti-poverty strategy will consist of measures to enhance economic growth prospects that will have the greatest impact on reducing poverty. A second major component of our anti-poverty program will be our efforts to fight corruption and reform the civil service.

30. A third component will involve social protection. Further improvements in social assistance will require reductions in the number of recipients of family allowances, with the savings used to finance increased minimum or social pensions, as well as community development programs. We intend to improve the targeting of the allocation mechanism for family allowances and strengthen the administrative capacity for monitoring and evaluation. Moreover, we intend to avoid making new social commitments that could be unsustainable in the medium term.

31. A fourth component of the anti-poverty program will be a revision of the pension system. The medium term goal is to strengthen the public pension system to provide security for old age pensioners while reducing the cost to the budget. In this regard, we will prepare a strategy for pension reform which provides a basis for such reforms. A fifth component will involve shifting government expenditure toward the poor (particularly in the education and health areas). A final component of the anti-poverty strategy will be labor market policies, where there is a need to increase unemployment benefits, streamline the legal framework, and liberalize employment regulations and remove various labor regulations that tend to delay the recovery in formal employment.

III. The Program for 2001

Macroeconomic Framework

32. Real GDP is expected to increase by at least 6.5 percent in 2001, reflecting the continuation of economic recovery and the effects of large expected private inflows from the Armenian diaspora, as well as higher tourism related to the celebration of the 1,700 year anniversary of Armenia's adoption of Christianity as its state religion. Inflation has been projected at 3.5 percent (end-period) and our monetary policy is aimed at achieving this, but the inflation and other macroeconomic projections may be reconsidered during the year, depending on developments.

Fiscal Policy

33. Given the dramatic build up in state budget and pension expenditure arrears starting in late 1999, related to the deterioration in budgetary tax revenues as well as shortfalls in external budgetary financing due to delays in EDC privatization, a significant adjustment effort is essential in 2001. We have already made a substantial adjustment in 2000, as evidenced by the upward trend in state budget tax revenues since June 2000, and the extent of adjustment during 2001, based on the budget approved by the parliament, will be even more substantial. In the 2001 state budget, which became law on December 31, 2000, tax revenue is projected to reach 15.1 percent of GDP in 2001 which, while still below the 1999 level, represents an increase (0.3 percent of GDP) over revenue in 2000. State budget expenditure, equivalent to 21.2 percent of 2001 GDP, represents a reduction (excluding capital expenditure and repair financed by SPA funds) of 0.9 percent of GDP compared to 2000, and would be 4.1 percent of GDP lower than in 1999. The overall state budget deficit (on an accrual basis) is projected to fall from 6.4 percent of GDP in 2000 to 4.0 percent in 2001. (However, if an agreement on rescheduling Georgia's debt to Armenia is reached, this will create an additional budgetary financing gap of 0.2 percent of GDP.)

34. In clearing budgetary expenditure arrears, the government is focusing its efforts on reducing socially significant arrears, such as family allowances, pensions, and wages. During the fourth quarter of 2000, dram 6 billion of arrears in these areas were cleared in net terms by arranging a short-term bridging loan from the SPA. To the extent that further domestic arrears clearance in 2001 will be feasible, the government will maintain the same priorities.

35. Pension arrears have been reduced to less than 1½ months. Although the SFSI's revenues are back loaded within 2001, we will nevertheless ensure that its stock of arrears does not increase in the first quarter of 2001. It will clear at least dram 1.0 billion in arrears in the second quarter of 2001, and by end-2001 will have eliminated all arrears.

36. Under the state budget, only about dram 17.2 billion of arrears (1.5 percent of GDP) could be cleared in 2001 in the absence of further debt relief and donor assistance. Given our track record in implementing this comprehensive and ambitious adjustment program, we expect additional financing will be obtained from a Consultative Group (CG) meeting which the World Bank plans to hold in the summer of 2001. However, if there is a residual financing gap even after these additional though uncertain sources of external financing, as is likely, we would need to carry over some amount of arrears into 2002.

37. In approving the budget, the parliament also enacted a comprehensive tax policy package. The package includes a broadening of the tax base (exemptions have been abolished including under the VAT and from the personal income tax, enterprise profits tax, and social contributions) and various structural measures to improve the efficiency of the tax system. It provides for extension of the VAT to the border from 30 percent of imported goods to 50 percent (based on 1999 trade data). The rate structure of the combined personal income tax/social security tax has been rationalized by replacing the highly dispersed marginal rates under the old regime with a combined flat rate.

38. The staff of the Ministry of State Revenues (MSR) will undergo a comprehensive performance review by end-May 2001. In parallel, the MSR has developed a job specific training program in cooperation with USAID, which will be implemented by end-December 2001. To enhance enforcement, the MSR will develop a plan, in coordination with the Ministry of Justice, to accelerate seizure and bankruptcy procedures by May 15, 2001. Under amendments to the Law on Taxes that took effect on January 1, 2001, tax and SFSI bodies are now required to initiate bankruptcy proceedings for any delinquent taxpayer or contributor within 183 days, which eliminates the scope for discretion and the associated opportunities for abuse. In addition, we will begin to publish lists of the names of delinquent taxpayers, on a quarterly basis, by May 8, 2001. To enhance the collection of non-tax revenues, the government will issue a decree that defines the responsibilities of the different state agencies in the collection process by May 1, 2001.

39. We will also take further measures to improve collections of mandatory social insurance contributions. Regarding customs, we will base our reform efforts on the implementation of the findings of the diagnostic workshop held in March 2000. We have set up an action plan (consisting, among other things, of the reform of the import and export processes, risk assessment, and intelligence activities), in cooperation with USAID and DFID, and will ensure its timely implementation.

40. We also intend to implement measures to enhance expenditure control. In this regard, we intend to complete a public expenditure review, in cooperation with the World Bank, by end-June 2002. We have submitted a draft treasury law to the parliament, and the government will make every effort to ensure its enactment by the parliament by end-June 2001. We plan to introduce commitment control procedures, on a pilot basis, in a few major ministries and departments, by end-June 2001. These procedures will be implemented in all other ministries/departments/state-governing territorial bodies by end-December 2001. We will also introduce a system of registering payments in the treasury on the basis of accruals by end-December 2001, which will help to improve the reliability of expenditure arrears reporting. Lastly, we already require local governments to report their cash expenditures on a monthly basis. Improving the internal audit procedures in the line ministries, the departments, and state-governing territorial bodies is a long-term goal. As a first step, we intend to approve the legal, procedural, and organizational basis for internal audit by end-December 2001. Thereafter, we propose to implement internal audit in all of the line ministries during 2002.

41. In line with the basic principle on the use of SPA proceeds (see paragraph 12), and with a view to limiting the use of such proceeds for capital expenditures in any year to broadly one-half of the amount in the SPA at the beginning of that year, in 2001 54 percent of this balance (after adjusting for repayment of the $15 million in bridge financing in late 2000) will be committed to capital expenditures (the corresponding figure in 2000 was 52 percent). In addition, at least 25 percent of the initial balance (after adjusting for repayment of the bridge financing) will be set aside for the retirement of non-concessional external debt, with the proviso that any reduction in the present value of the stock of debt arising from debt rescheduling agreements could be used to reduce the amount of the set-aside.

Monetary, Exchange Rate, and Banking Sector Policies

42. The monetary program for 2001 is designed to maintain monetary growth at a level consistent with price stability. Given the 33 percent growth in reserve money in the second half of 2000 related to foreign inflows and spending of SPA money (on capital expenditures and to reduce budgetary expenditure arrears), we believe it is essential to bring the rate of reserve money growth down very significantly in 2001, especially in the first half. If inflation developments during the first half are higher than envisaged, the CBA will consult promptly with the IMF staff with a view to a possible further tightening of the monetary program.

43. Dram broad money is expected to remain flat in 2001 given the extraordinarily rapid growth in the monetary aggregates in the second half of 2000. The projected growth of broad money (12 percent) is based on the expectation of continuing strong growth in foreign currency deposits and an increase in reserve money of 2 percent. The 2001 program will target the dram equivalent of a $6 million (end-year to end-year) increase in the net official international reserve position of the CBA, which together with disbursements under the PRGF will enable the central bank to maintain import coverage of gross reserves of over 3½ months of imports.

44. The CBA intends to strengthen its prudential regulations to enhance further the soundness of the banking system. The CBA and the government intend to issue and implement a loan classification system, which is in accordance with international best practices, and takes into account the capacity of borrowers to service their loans, by end-June 2001. The CBA and the government also intend to introduce a new "watch" category to the loan classification system and to provision for loans in this category by a greater amount than for standard loans, by end-June 2001. The CBA will further develop valuation methodologies with respect to loans and collateral and introduce new provision rules that are consistent with international best practices, and more closely tailored to the risks prevailing in the Armenian economy, by end-December 2001. The CBA has already issued guidelines for the measurement and management of foreign exchange, interest rate, and liquidity risk by commercial banks, and intends to issue guidelines for credit risk by end-December 2001. Minimum capital requirements for existing banks, presently $1 million, will be increased to $1.3 million by end-June 2001, $1.5 million by end-June 2002, $2 million by end-June 2003, and to the same level as new banks ($5 million) by end-June 2005. The CBA has also decided to establish a credit bureau, among the banks, to fill the gap in credit information about companies, by end-February 2002.

45. In order to strengthen the CBA's ability to deal effectively with problem banks (including by giving the CBA power to change the management of insolvent banks and banks that are solvent but fail to comply with prudential requirements), the CBA has submitted a new draft Law on Bankruptcy of Banks to the government, and the government will submit a draft to the parliament by end-June 2001, with a view to obtaining parliamentary approval of the law by end-October 2001. The new law would enhance the ability of the CBA to deal adequately with insolvent banks. In particular, it should be drafted in a manner that would enable the central bank to undertake swift action in bank bankruptcy cases. The government will submit draft amendments to the parliament of the CBA Law and/or the Law on Banks and Banking Activity by end-June 2001, and make every effort to ensure parliamentary approval of these amendments by end-December 2001, in order to enhance the CBA's authority to require implementation of remedial action, including decisions to terminate a bank license or initiate the bankruptcy of a bank, and to give the CBA the authority to confirm any changes in bank ownership. The CBA and the government will take the necessary steps to strengthen penalty provisions, if necessary by incorporating these changes into law.

46. The government is firmly committed to maintaining the independence of the central bank, and will not enact or support any legislation or legislative initiative that may infringe upon the independence of the central bank, in terms of management, functions, or operations. Should a draft Law on Statutes be proposed that could possibly infringe upon the independence of the central bank, the government will propose that the draft classify CBA Board resolutions as legal statutes and not as acts of a state agency. The government will submit a draft law, or draft amendments to existing laws, to provide for appropriately regulated non-bank financial institutions, and bank reorganizations, to the parliament by end-December 2001. Also, the government will review and submit amendments to the Securities Market Regulation Law to the parliament by end-June 2001, with a view to adoption by end-December 2001, to ensure that the activity of domestic banks in the government securities market is not regulated by this law, and that banks can engage in dealing and brokerage activities without special licensing from the Securities Commission.

Balance of Payments and External Financing

47. Notwithstanding the significant narrowing of external imbalances in recent years, the balance of payments remains vulnerable. In 2001, higher economic growth and investments are likely to boost imports, thus limiting the scope for a further narrowing of the external current account deficit. Even though foreign direct investment is expected to remain buoyant—in part because of the planned privatization of the EDCs and other investments into the energy sector—the capital account surplus is not expected to finance the current account deficit fully.

48. An external financing gap of $96 million is projected for 2001, which reflects an overall balance of payments deficit of $45 million, a targeted reserve build-up of $23 million (so as to achieve gross reserves equivalent to over 3½ months of imports), IMF repayments of $10 million, and $19 million of arrears clearance to Russia. The financing gap is expected to be filled in part by first-year disbursements under the PRGF arrangement ($26 million) and the World Bank's SAC IV ($50 million). To fill the residual financing gap of $20 million, additional donor support would also be needed, and as noted above the World Bank plans to hold a CG meeting in the summer of 2001.

Quasi-fiscal Sectors

49. In the energy sector, we intend to send final agreed tender documents to potential bidders in the competitive tender for privatizing the EDCs, conducted under the World Bank supported program, by July 9, 2001. Moreover, we intend to improve the transparency and monitoring of the financial performance of the quasi-fiscal sectors under the program. In this regard, we have already included the projected financing gaps for the key quasi-fiscal sectors (energy, irrigation, and water and sewage companies) in the message of the government accompanying the 2001 budget approved by the parliament. As a first step toward incorporating explicit financial targets for the quasi-fiscal sectors into our program, and on the basis of quarterly projections, we have established semiannual floors for the primary balance of the energy sector for 2001. While the data are not presently available to specify semiannual financial targets for the other key quasi-fiscal sectors (irrigation and water and sewage companies), we intend to develop a mechanism for monitoring the financial performance of these sectors on a semiannual basis by end-December 2001, starting with Yerevan Water and Sewage Company by end-June 2001. In the meantime, we have established annual floors for 2001, for the primary balances of these quasi-fiscal sectors. We will also work to produce annual cash flows for district heating and the company Nairit that are adequate for the purpose of setting financial targets.

50. In addition, concerning the energy sector, the government has already issued a decree that obliges the MSR, the Ministry of Energy, and the MFE to use the same methodology for the determination of tax liabilities (including penalties and fines). Moreover, we will issue a decree that prohibits state-owned enterprises from supplying goods and services to (or on behalf of) the power sectors, without written agreements on the goods and services to be supplied, their prices, and terms of payment (deadlines, interest on credit, and penalties on late payments) by end-May 2001. We intend to issue a detailed report to the parliament and the IMF staff on the terms of the 1998 gas-for-equity swap, including how this deal was reflected in the accounts of the state budget and the balance sheets of participating companies, by end-June 2001.

Governance

51. We are firmly committed to following through on our efforts to improve governance and reduce corruption. Efforts to combat corruption will be coordinated by the Prime Minister's recently established anti-corruption commission, which has been charged with elaborating a major program of actions in this area. As an important first step in our efforts to fight corruption, we have submitted a revised draft law on financial disclosure of public officials to the parliament, taking into account the extensive comments already received from IMF staff, and will make every effort to ensure parliamentary approval of this law by end-June 2001. In parallel, we intend to achieve enactment of a new civil service law, which has been developed in close cooperation with the World Bank staff. To ensure progress in the program to define government functions, the working group (see paragraph 25) will submit a concept paper to the government and to the public by end-June 2001.

52. To improve reporting of fiscal data to the public, by end-June 2001 we will start to publish monthly comprehensive reports (including revenues, expenditures, financing, receivables, and payables) on budget execution and accounts on a pilot basis, and based on the results of the pilot we intend to institute the reporting for all ministries by end-December 2001. These reports will contain detailed information on the use of external grants and loans, privatization transactions and the use of privatization proceeds, the financial condition of major state-owned enterprises (quarterly reports only; we will refine the list of such enterprises by end-June 2001), budget execution relative to the approved budget, and the status of tax and expenditure arrears. In addition, all ministries, departments, and state-governing territorial bodies will provide annual reports on their performance. Finally, we have hired an external auditor—through international tender—for the use of SPA proceeds.

53. Moreover, we intend to implement a number of measures related to improvements in tax administration, and other structural fiscal measures, which are linked to improved transparency and governance. In particular, our program envisages the implementation of a comprehensive audit program in cooperation with USAID. As a first step, we will put in place a fully operational system of VAT cross-checks, based on the receipts collected through audits. By end-May, we will complete the regulatory framework (i.e., the government decree providing the data format), with a view to having in place a fully operational system of VAT cross-checks by end-June 2001. By end-June 2001, the comprehensive automated audit system will be operational in all Yerevan offices. To support the audit program, we will develop rules for the collection of information and the application of indirect audit methods. By end-December 2001, we will extend the automated system to all tax offices.

Prior Actions

54. We have taken or will take the following prior actions before the IMF Executive Board considers our request for an arrangement under the PRGF:

• Replenish in the first quarter of 2001 the SPA by the full amount borrowed from it in late 2000;

• Meet cumulative state budget tax revenue targets for the relevant periods (dram 21.0 billion for January-February, dram 35.5 billion for January-March, and dram 50.0 billion for January-April, 2001);

• Ensure no increase in the stock of state budget arrears after end-December 2000;

• Ensure no increase in the stock of SFSI arrears after end-December 2000;

• Clear/restructure all external arrears;

• Conform to the monetary program for the relevant periods;

• Submit to the parliament a draft treasury law, prepared in consultation with the IMF staff;

• The government will have signed a contract with an external auditor—hired through international tender—for the use of SPA proceeds; and

• Submit to the parliament a revised draft law on financial disclosure of public officials, prepared in consultation with the IMF staff.

Program Monitoring and Reporting Requirements

55. Program monitoring will be carried out on the basis of semiannual quantitative performance criteria and quantitative benchmarks, structural performance criteria, and structural benchmarks, for the period January 1, 2001 to December 31, 2003, with semiannual reviews based on performance as of end-June and end-December of each program year. Quantitative performance criteria have been set for June 30 and December 31, 2001, and quantitative benchmarks have been set for September 30, 2001. The quantitative performance criteria include: (i) a ceiling on the net domestic assets of the CBA; (ii) a ceiling on net domestic banking system credit to the central government; (iii) a ceiling on state budget arrears; (iv) a ceiling on SFSI arrears; (v) a floor on state budget tax revenues; (vi) a ceiling on the overall cash deficit of the state budget; (vii) a floor on the primary balance of the energy sector; (viii) a ceiling on net disbursements of short-term external debt; (ix) a ceiling on contracting and guaranteeing of new non-concessional medium- and long-term external debt longer than one year (with a sub-ceiling on debt of 1-5 year maturities); (x) a ceiling on external arrears (continuous performance criterion); and (xi) a floor on net official international reserves. An indicative floor and ceiling have also been set on reserve money for June 30, September 30, and December 31, 2001. Quantitative performance criteria and benchmarks, and indicative targets, are shown in the attached Table 1. Adoption by the parliament and signing by the president by end-June 2001 of a law on financial disclosure of public officials—that would: (i) require public officials to report their incomes and assets in accordance with the procedures established by that law; and (ii) imposes liability for failure to make the required disclosure—will be a structural performance criterion under the program. Structural benchmarks during the first program year are summarized in the attached Table 2. Details on the definition and monitoring (and adjustors) of quantitative performance criteria and indicative targets are set in the Technical Memorandum of Understanding (attachment I to this Memorandum). All data necessary for the effective monitoring of the program, which are specified in the Technical Memorandum of Understanding, will be reported in a timely manner to the IMF by the government, the CBA, and the National Statistical Service (NSS).

56. We believe that the policies detailed above are adequate to achieve the objectives of the program, but we remain prepared to take any additional measures that may be necessary for this purpose.

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Republic of Armenia
Technical Memorandum of Understanding

Armenia's performance under the PRGF-supported program will be assessed by the IMF on the basis of the observance of quarterly quantitative performance criteria and indicative targets as well as on compliance with structural performance criteria and benchmarks. This Technical Memorandum of Understanding (TMU), including attached tables, sets out and defines the performance criteria (and adjustors) and indicative targets as well as the monitoring and reporting requirements. It also sets out and defines the prior actions.

I. Quantitative Targets

1. Quantitative targets for 2001 are presented in Table 1 and defined below. Benchmarks are set for end-March and end-September and performance criteria for end-June and end-December. Other concepts needed for the proper definition of the quantitative targets are also defined.

Reserve money

2. The reserve money targets are indicative only and include both a floor and a ceiling. Reserve money of the Central Bank of Armenia (CBA) is defined as the sum of currency issue, required and excess reserves including on foreign currency deposits, and current and time deposit accounts of certain resident agents. Thus defined, the outstanding stock of reserve money amounted to dram 72,390 million on December 31, 2000.

3. The target for reserve money will be subject to a daily corridor consisting of upper and lower limits on the reserve money path. The width of the corridor in 2001 (plus or minus 2.0 percent) has been established based on the quarterly average standard deviation of excess reserves held by banks in percent of quarterly average reserve money during the period 1996-2000. Whenever reserve money breaches the corridor, the CBA will consult promptly with IMF staff regarding the appropriate policy response.

Net official international reserves

4. The program targets a minimum level of net official international reserves (NIR) of the CBA. The stock of such reserves will be calculated as the difference between total gross international reserves and total official reserve liabilities.

5. Total gross official international reserves shall be defined as the CBA's holdings of monetary gold (excluding amounts pledged as collateral or in swaps), holdings of SDRs, any reserve position in the IMF, and holdings of convertible currencies (i.e., those listed in Table 2) in cash or in nonresident financial institutions (deposits, securities, or other financial instruments). Gross reserves held in the form of securities are marked to market. Gross reserves are reported net of the value of the balance on the government's Special Privatization Account (SPA). Capital subscriptions in foreign financial institutions and illiquid foreign assets are also excluded.

6. There is no reporting on financial derivatives and other off balance sheet positions as the CBA does not currently trade in such financial instruments. However, if the CBA decides to commence such trading it will promptly notify the IMF staff to establish proper reporting requirements in this regard.

7. Official reserve liabilities shall be defined as outstanding liabilities to the IMF, and convertible currency (i.e., those listed in Table 2) liabilities of the CBA to nonresidents with an original maturity of up to and including one year.

8. NIR is monitored in U.S. dollars, and, for program monitoring purposes, assets and liabilities in currencies other than the U.S. dollar shall be converted into dollar-equivalent values using the exchange rates as of December 31, 2000 as established by the CBA (Table 2). Thus defined, NIR was US$138.3 million on December 31, 2000.

Net domestic assets of the CBA

9. The program targets a maximum level of net domestic assets (NDA) of the CBA. NDA of the CBA is defined as reserve money less NIR, where the dram-equivalent value of NIR is calculated using the end-2000 official exchange rate of dram 552.18 per U.S. dollar. Thus defined, the outstanding stock of the CBA's NDA amounted to minus dram 3,970 million on December 31, 2000.

10. NDA is composed of: (1) net credit to the general government; (2) outstanding credit to domestic banks by the CBA (including overdrafts) minus liabilities not included in reserve money, exclusive of accrued interest; and, as a residual (3) other items (net).

Government

11. Unless otherwise noted, government is meant to include the central government (the budget of which will henceforth be referred to as the "state budget"). The State Fund for Social Insurance (SFSI), whose overall cash balance must be zero on an annual basis, will be monitored by a separate performance criterion covering the stock of SFSI arrears. Local governments—which are not allowed to borrow either domestically or externally—are excluded from the definition of government as there are long lags in the reporting of the activities of these entities.

Kreditanstalt fur Wiederaufbau SME onlending facility to commercial banks

12. An onlending facility credit from the Kreditanstalt fur Wiederaufbau (KfW) to commercial banks is channeled through the CBA. For program purposes, disbursements under this credit are recorded in the central government's accounts as foreign-financed onlending. In the monetary accounts the CBA's liability to KfW is included in other items net.

Banking system and commercial banking system

13. The commercial banking system is the consolidation of all banks licensed by the CBA to conduct banking business. The banking system is the consolidation of the CBA and the commercial banking system.

Ceilings on domestic banking system net credit to central government

14. Net credit from the CBA to the central government includes the CBA's holdings of treasury bills and treasury bonds less central government deposits (including deposits of donor-financed project implementation units and balances of proceeds from the sale of humanitarian assistance). Treasury bonds are valued at the purchase price and treasury bills are valued at the purchase price plus the implicit accrued interest. Except for treasury bills, accrued interest is excluded from net credit. The CBA does not extend direct credit to the central government. The source of the data to be used is specified in paragraph 33.

15. Net credit from commercial banks includes: (1) gross credit from banks to the central government less central government deposits with banks (excluding accrued interest); and (2) banks' holdings of treasury bonds (valued at the purchase price and excluding accrued interest) and treasury bills (valued at the purchase price plus the implicit accrued interest).

16. Accordingly, net credit of the banking system to the central government is the sum of net credit from the CBA and net credit from commercial banks. Thus defined, net domestic banking system credit to the central government was dram 9,373 million on December 31, 2000.

Ceilings on the contracting and guaranteeing of new nonconcessional external debt by the government and by the CBA

17. External debt limits apply to new medium- and long-term external debt ¹ with original maturities of more than one year, which are contracted or guaranteed by the government (as defined above) or by the CBA, with a sublimit on such debt with maturities of more than one year up to and including five years. In addition, there are limits on disbursements of short-term external debt contracted or guaranteed by the government or the CBA; all obligations with original maturities of up to one year fall under this limit, except normal import-related credits. The outstanding stock of short-term external debt on December 31, 2000 was zero.

18. The program ceilings on the contracting and guaranteeing of new nonconcessional medium- and long-term debt, by the government or the CBA, will apply to all forms of external debt, as defined in paragraph 17 of the TMU, with maturity greater than 1 year. The only liabilities excluded from the limits are sales of treasury bills or treasury bonds to nonresidents, provided the sales go through the regular auction mechanism and involve no exchange rate guarantees; and concessional loans. For program purposes, a loan is considered concessional if the grant element is at least 35 percent calculated using a discount factor based on the Commercial Interest Reference Rates (CIRRs) published by the OECD plus margins depending on the loan maturity. ² The average of the CIRRs over the last ten years will be used for loans with a maturity of at least 15 years and the average of the CIRRs for the preceding six months will be used for shorter maturities. For the purpose of monitoring compliance with the targets, all agreements concluded in respect of rescheduling or refinancing of existing debt shall be excluded from the limits. Transactions subject to these ceilings shall be valued in the contracted currencies and converted into U.S. dollars at the average monthly market exchange rate in the month when the borrowing commitment was contracted.

Ceilings on external arrears

19. External arrears of the central government or the CBA will consist of all overdue debt-service obligations (i.e., payments of principal and interest) arising in respect of loans contracted or guaranteed by the government or the CBA since Armenia's independence, unpaid penalties or interest charges associated with these arrears, and overdue payments owed by the government or the CBA on imports received subsequent to independence. Thus defined, external arrears at end-December 2000 were $19.0 million.

Limits on the state budget balance

20. The state budget balance during a given period is defined from the financing side on a cash basis as the sum of domestic banking system net financing, domestic non-bank net financing, and external net financing.

21. Domestic banking system net financing is measured as the change during the period of net domestic banking system credit to the state budget. The source of the data to be used is specified in paragraph 33.

22. Domestic non-bank net financing is measured as the sum of: (1) the change during the period of outstanding treasury bills and bonds to non-banks (including accrued interest for treasury bills and excluding accrued interest for treasury bonds); ³ and (2) any other disbursement or transaction (other than proceeds from privatizations which are deposited into the SPA) that increases non-banks' claims on the central government, less amortizations made by the central government to private resident non-bank agents. These data will be provided by the Ministry of Finance and Economy (MFE) in consultation with the CBA.

23. External net financing is measured as total debt-increasing disbursements from non-residents to the central government less total amortizations from the central government to non-residents. All foreign-currency denominated transactions are recorded in drams using the prevailing exchange rate at the time of the transaction.

Privatization proceeds

24. Proceeds stemming from the selling of enterprises in the context of the government's annual privatization program (i.e., enterprises listed in the government's list of enterprises to be privatized in accordance with the law on privatization) are deposited into the SPA. The account is held at the CBA and the proceeds are invested abroad together with the CBA's international reserves. However, as noted above, these proceeds are not included in the definition of the monetary accounts of the banking system. Any withdrawal from the SPA (including accrued interest) will be accounted for as privatization proceeds used to finance the state budget (as defined above).

25. Proceeds from other privatizations are included in the regular budgetary accounts as capital revenue. These proceeds are either deposited in a privatization account, held at the CBA and included in the definition of net credit to the central government, or spent for general budgetary purposes.

Tax revenues of the state budget and the SFSI

26. Tax revenue is defined in accordance with Government Finance Statistics (GFS) 1986, section IV.A.1. The MFE will report total tax revenue to the IMF, on a monthly basis and within seven days of the end of each month, using the following categories: VAT, excises, enterprise profit tax, personal income tax, land tax, customs duties, presumptive income tax, property tax, and other taxes (including environmental taxes).

Central government and SFSI arrears

27. The program targets a maximum level of the stock of central government arrears. It also targets a maximum level of the stock of SFSI arrears. For program purposes, arrears are defined as follows. With respect to wages, pension payments, family allowances, amortization, and interest payments, the stock of arrears is defined as all unpaid claims outstanding as of the end of the month. For all other expenditure categories, arrears are defined as the stock of unpaid claims, as verified by the recipient of the goods and services, which has been outstanding for more than 30 days as of the end of the month. The reports on the arrears (in the format of Table 3) will be compiled monthly by the MFE for the central government and the SFSI separately, and reported by the MFE to the IMF within 45 days of the end of each month.

Energy sector cash flows

28. The government will provide a detailed quarterly cash flow for the energy sector. The energy sector is defined to consist of the following companies: (1) Hrazdan thermal power plant; (2) Yerevan thermal power plant; (3) Metsamor nuclear power plant; (4) Sevan-Hrazdan Cascade hydro-power plant; (5) Vorotan hydro-power plants system; (6) High Voltage Electricity Network; (7) Armenergo; (8) Yerevan Electricity Network; (9) Northern Electricity Network; (10) Southern Electricity Network; (11) Central Electricity Network; (12) Armgazprom; and (13) Armtourtrade. The cash flow of the energy sector consists of the consolidation of the cash flows of these enterprises. Four of the companies are scheduled to be privatized in 2001 and starting in the quarter following a privatization of a company, this company will be omitted from the definition of the energy sector. The cash flow information—to follow the format of the attached sample Table 4 ⁴—will be provided to the IMF no later than 28 days after the end of each quarter.

29. The program will target the primary balance of the energy sector, where the primary balance is defined as current revenues less total expenditures excluding all interest payments and capital expenditures related to foreign-financed projects, i.e., foreign-financed and co-financed capital expenditures.

II. Reporting Requirements

30. The government, the CBA, and the National Statistical Service (NSS) will provide the IMF with all necessary economic and financial statistical data to monitor economic developments and program performance including, but not necessarily limited to, the following specific information. Unless otherwise indicated, the requested information will be in accordance with the definitions elaborated in the previous section.

The balance sheet of the CBA

31. The CBA has provided the IMF staff the chart of accounts and it will notify the staff of any revisions thereto.

32. Weekly (summary ⁵) and monthly end-of-period (by chart of account) data on the balance sheet of the CBA will be reported to the IMF by the CBA within seven days of the end of the reporting period. The information will clearly provide the basis for calculating the following items: NIR, NDA of the CBA, net credit from the CBA to government (including separate lines for the central government, SFSI, and local governments), net credit provided to commercial banks (by type of credit), and any other financing provided to the rest of the economy.

The balance sheet of the banking system

33. Monthly banking system data, in the form of a monetary survey, as well as the consolidated balance sheet of the commercial banking system (by chart of accounts), will be reported to the IMF by the CBA within 21 days of the end of each month. The information will clearly provide the basis for calculating the following items: net foreign assets (NFA) and NDA of the banking system, net credit to government (including separate lines for the central government, SFSI, and local governments), and other financing provided to the rest of the economy.

34. Dram broad money of the banking system is defined as the total of currency outside banks, plus banking system deposits of resident households and enterprises in drams, excluding accrued interest. Thus defined, dram broad money does not include deposits of the central government, SFSI, or local governments. Accrued interest on deposits held with commercial banks will be recorded in other items net.

35. Broad money is defined as dram broad money and foreign currency deposits of resident households and enterprises in the banking system.

Treasury bill and coupon bond financing

36. The CBA will provide monthly data to the IMF within seven days of the end of each month on the amount of treasury bill and coupon bond holdings by the following categories of holders: the CBA, resident banks, resident non-banks, and nonresidents.

International reserves

37. The CBA will provide monthly data (by chart of accounts) within 14 days of the end of each month on both gross and net official international reserves. These data will be provided in two variants: (1) at program exchange rates; and (2) at actual official exchange rates.

Nontax and capital revenue

38. The MFE will report on a monthly basis non-tax revenues, capital revenue, cash grants and proceeds from the sales of humanitarian assistance. This information will be reported within seven days of the end of each month.

External debt

39. The MFE, in collaboration with the CBA, will provide information on the disbursements and outstanding stock of short-term external debt; on contracting and guaranteeing and the outstanding stocks of medium-and long-term external debt of the government and of the CBA; and any stock of outstanding arrears on external debt service payments within 21 days of the end of each month. In addition, the MFE will report the total amount of outstanding government guarantees and external arrears with the same reporting frequency.

Tax arrears

40. The Ministry of State Revenues will report on an end-of-month basis the amount of outstanding tax arrears, by the end of the following month.

Budgetary sector employment

41. The MFE will provide quarterly updates on budgetary employment by ministries, and on average budgetary sector wages, within one month following the end of each quarter.

Budgetary and extra budgetary data

42. Quarterly data on budgetary execution will be reported to the IMF by the MFE and the SFSI within one month following the end of each quarter. All cash receipts, all cash expenditures (including debt-service payments), and external and domestic borrowing operations will be part of this report. Expenditure data will be provided according to both economic and functional classifications, consistent with GFS methodology. In addition, budgetary financing by the MFE will be reported by economic and functional classification on a monthly basis by the end of the following month.

Non-budgetary domestic arrears

43. The MFE will coordinate—in collaboration with the Ministry of Energy, the CBA, and the NSS—a report to the IMF on a monthly basis on the stock of arrears of the 50 largest enterprise debtors which are in arrears to the banking system, and energy arrears of households and enterprises. This information is to be provided within 28 days of the end of each month.

Balance of payments data

44. The NSS will provide: (1) on a monthly basis detailed export and import data within 28 days of the end of each month; and (2) on a quarterly basis a balance of payments within two months of the end of each quarter.

Energy sector payable and receivable debts

45. The MFE will provide monthly reports on the end-of-month stock of accounts payables and accounts receivables of the consolidated energy sector (defined in paragraph 28) with a lag of no more than 28 days.

Privatization proceeds and use of privatization proceeds for budgetary support

46. The CBA will provide to the IMF information on: (1) the balance on the SPA at the end of each month; and (2) all gross additions and gross withdrawals on a daily basis during each month. The information will be provided on a monthly basis no later than seven days after the end of each month.

Other financial sector information

47. The CBA will provide information on the foreign exchange market (including the official, buying, and selling exchange rates, inter-bank turnover, and the volume of CBA sales and purchases) and interest rates by maturities (including the refinance rate, the inter-bank rate and volumes, the treasury bill and coupon bond yields and volumes by maturity, and bank deposit and lending rates by maturity). The CBA will also provide data on commercial banks' prudential ratios (including liquid asset ratios, capital adequacy ratios, open foreign exchange limits, and percentage of classified loans by category). These data will be provided on a monthly basis within 21 days of the end of each month. In addition, the CBA will provide other data as specified in CBA Resolution No. 201 (December 6, 1999).

Real sector information

48. The NSS will notify the IMF of the monthly CPI by category by the fifth day of the following month, and convey quarterly GDP estimates within two months of the end of each quarter.

III. Prior Actions

49. The program's prior actions in the structural policy area are deemed to have been complied with if the following conditions have been met:

• Replenishment in the first quarter of 2001 of the SPA by the full amount borrowed from it in late 2000;

• The CBA, as instructed by the government, has transferred funds sufficient to clear all external payments arrears that have not been restructured.

• A draft treasury law, prepared in consultation with IMF staff, has been submitted by the government to the parliament;

• The government has signed a contract with an external auditor regarding the use of SPA proceeds, hired through international tender, and the government has provided the IMF staff with a copy of the tender documents;

• A revised draft law on financial disclosure of public officials, prepared in consultation with the IMF staff, has been submitted by the government to the parliament.

50. Compliance with the program's quantitative prior actions will be verified through the regular reporting procedures.

IV. Structural Performance Criterion

51. Adoption by the parliament and signing by the president by end-June 2001 of a law on financial disclosure of public officials that would: (i) require public officials to report their income and assets in accordance with the procedures established by that law; and (ii) impose liability for failure to make the required disclosure.

V. Program Adjustors

52. The ceiling on central government arrears will be adjusted: (1) downward by the full amount of the share of 2001 debt service to Russia (dram 2,514 million in the first quarter of 2001, dram 5,008 million (cumulatively) in the first through the second quarter, dram 7,465 million in the first through third quarters, and dram 9,920 million in the first through fourth quarters) not to be serviced in the context of a possible debt rescheduling agreement; (2) upward by the full amount of any foregone repayment in the context of a possible debt rescheduling agreement with Georgia (zero in the first quarter of 2001, dram 1,078 million in the first through the second quarter, dram 1,078 million in the first through third quarters, and dram 2,156 million in the first through fourth quarters); and (3) downward by the full amount of higher than programmed external grants (dram 4,753 million in the first quarter of 2001, dram 6,943 million in the first through the second quarter, dram 9,668 million in the first through third quarters, and dram 14,393 in the first through fourth quarters).

53. The central government's budgetary cash deficit will be adjusted: (1) upward by the full amount of 2001 principal payments to Russia (dram 1,742 million in the first quarter, dram 3,484 million in the first through the second quarter, dram 5,226 million in the first through third quarters, and dram 6,970 million in the first through fourth quarters) that need not be paid in the context of a possible debt rescheduling or other restructuring agreement with Russia; and (2) upward (downward) by the amount of higher (lower) than programmed foreign-financed project disbursements. Adjustment lending by the World Bank is not included in the adjustor.

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