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

Dhaka, Bangladesh, June 4, 2003

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, DC
USA

Dear Mr. Köhler:

The Government of Bangladesh has adopted an economic reform program for FY04-FY06, which aims to accelerate economic growth and poverty reduction. To achieve these goals, the Government assures you of its determination to pursue sound macroeconomic policies, take actions to enhance the climate for investment, strengthen economic governance, and reform the tax system, nationalized commercial banks, and the state-owned enterprises. This overall strategy is laid out in our National Poverty Reduction Strategy (I-PRSP). The details of the program are set out in the attached Memorandum on Economic and Financial Policies (MEFP). In support of this program, we are requesting a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) arrangement in an amount equivalent to SDR 347 million (65 percent of quota).

The Government will provide the Fund with information on a timely basis as might be requested in connection with the progress in implementing the PRGF-supported program.

The Government believes that the policies and measures set forth in the MEFP are adequate to achieve the objectives of the program, but will take supportive measures as necessary for this purpose. During the period of the arrangement, the Government will consult with the Managing Director, on its own initiative or at your request, concerning the adoption of appropriate measures. The Government will conduct with the Fund staff the first review of the PRGF-supported program, to be completed no later than December 2003 and the second review, to be completed no later than June 2004. Moreover, while the Government has financial obligations to the Fund arising from loans under this arrangement, it will consult with the Fund from time to time, on its own initiative or at the request of the Managing Director on Bangladesh's economic and financial policies.

To facilitate wider distribution of the MEFP and the I-PRSP, the Government has authorized their publication by the Fund.

With my best regards,

BANGLADESH

Memorandum of Economic and Financial Policies for May 2003-June 2004

June 4, 2003

I. Introduction

1. Since taking office in October 2001, the BNP-led government has made progress in restoring macroeconomic stability and renewing structural reforms, in spite of a difficult global environment. Building on this record, the government is now ready to embark on a comprehensive reform program to reinforce the initial gains and to address the medium-term challenges of moving the economy to a higher growth path and faster poverty reduction. This program is based on the strategy articulated in our interim Poverty Reduction Strategy Paper (I-PRSP). To implement this program, we are seeking support through a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF). This memorandum lays out the medium-term macroeconomic and structural policy framework, and the main objectives and policies that we intend to pursue for the remainder of FY03 and for FY04.

II. Recent Economic Performance

2. The economy of Bangladesh is undergoing a recovery and inflation remains manageable. Over the first half of FY03, industrial production and exports have rebounded by 5 percent. Real GDP growth is thus expected to recover to an estimated 5.2 percent for FY03, driven by agricultural production and strong domestic demand. Meanwhile, CPI inflation has risen to 5.9 percent as of February, due largely to higher food prices linked to weather factors and fuel price adjustment. Nonetheless, inflation for FY03 on average should be around 5 percent. Gross international reserves have been rebuilt to around $1.8 billion (or two months of import cover) at mid-May, from the low of $1 billion reached in November 2001.

3. Fiscal prudence has contributed to achieving this stability. Specifically, the central government deficit (excluding grants) was reduced from 5.1 percent of GDP in FY01 to 4.7 percent (or 3.7 percent including grants) in FY02, on account of both revenue measures and expenditure discipline. In particular, Annual Development Program (ADP) spending was cut by 8 percent in nominal terms, or 0.9 percentage points of GDP. The FY03 budget targets a further reduction in the deficit to 4.2 percent of GDP, and in domestic financing of the budget to 1.9 percent of GDP (from 2.5 percent in FY02).

4. Revenue measures announced in the budget included withdrawal of tax holidays for expansion of existing enterprise units, lowering of the minimum income tax threshold, abolition of zero duty rates and supplementary duties on many imports, lowering of the top customs duty rate from 37.5 percent to 32.5 percent, withdrawal of some income tax exemptions, and extension of the VAT net within the retail sector. Moreover, measures to reduce discretion of officials in tax administration were introduced.

5. In addition, budget management has been improved, including through monthly monitoring of fiscal performance based on a computerized budgeting and accounting system, and through systemic monitoring of releases of ADP-related funds. For the first time, a comprehensive mid-year review of the budget has been undertaken to ensure attainment of budget targets. In addition, to help design the medium-term budget strategy, Revenue and Expenditure Commissions have been established, and their initial reports have been received. Their interim recommendations are being taken into account in developing the FY04 budget.

6. Monetary policy has also been kept tight, and excess bank reserves have been reduced substantially. Reserve money remained flat over 2002, through sales of treasury securities by Bangladesh Bank (BB). Along with fiscal restraint, this facilitated the rebuilding of NIR, and interest rate on treasury bills has risen to about 8 percent (from 4 percent in May 2002). A repo facility was introduced in June 2002 and a reverse repo in April 2003 to improve liquidity management. The firm fiscal and monetary stances have contributed to the stability of the exchange rate, following the 1.5 percent devaluation in January 2002. In November 2002, the interbank and curb rates moved significantly above the official rate due to large volumes of opening of letters of credit, reflecting depreciation expectations, and a temporary increase in the government's domestic financing requirement. However, exchange pressures have abated and the rate has been kept at appropriate, broadly stable levels over the last six months, with the curb market premium remaining below 2 percent, thanks to timely tightening of financial policies.

7. Significant steps have also been taken to renew the momentum of structural reforms. In particular:

• Adamjee jute mills was closed in July 2002. This was the largest jute mill in the world and accounted for 10 percent of annual SOE losses. The retrenchment package for 26,000 workers of Adamjee is estimated to cost about Tk 4 billion (0.1 percent of GDP). In addition, closure/privatization of an additional 34 SOEs is estimated under the revised budget to cost a further Tk 7.6 billion (0.2 percent of GDP), mostly on retrenchment.
  
  
• SOEs are being subject to harder budget constraint as reflected in reduced credit from the nationalized commercial banks (NCBs). Also, government guarantees, including suppliers' credits, are being restricted.
  
  
• Energy prices were raised in January and September 2002 on motor spirits (22 percent), diesel and kerosene (10 percent), power and electricity tariffs (7-8 percent), and natural gas (10 percent). In January 2003, petrol and diesel prices were increased by a further 17 percent. These actions are expected to substantially reduce losses in the energy sector.
  
  
• In the banking area, the Bangladesh Bank Order was amended to strengthen BB's operational autonomy and bank supervision. Furthermore, the Banking Companies Act and Banks (Nationalization) Act were amended to bring the NCBs and development finance institutions (DFIs) under the greater supervision of the BB and to improve corporate governance. The Money Loans Court Act has also been modified to speed up debt recovery, and the Money Laundering Prevention Act has been passed, aimed at preventing illegal financial transactions. To strengthen private commercial banks, the BB has raised minimum capital requirements from eight to nine percent of risk-weighted assets, and has taken steps to reduce insider lending and introduce rules for writing off bad debt. With respect to the NCBs, 65 loss-making branches have been closed so far this fiscal year.

III. Medium-Term Macroeconomic Framework and Poverty Reduction Strategy

8. Despite encouraging economic results so far, the economy is fragile and the outlook is clouded by external uncertainties. Moreover, economic growth remains below potential and poverty incidence, while reduced substantially, remains high. In these circumstances, our reform strategy is aimed at putting the economy on a firmer footing, and at laying the basis for higher sustainable growth and a tangible reduction in poverty.

9. In order to halve the poverty rate by 2015, a goal set in our I-PRSP, growth over the medium to long term must be raised to at least 7 percent in conjunction with pro-poor policies. To attain this ambitious target, larger investment by a more vibrant private sector (including FDI) will be required, as well as a further building up of human and physical capital. To these ends, under the PRGF, priorities will be given to the following: ensuring a stable macroeconomic environment and prudent management of public resources—particularly through tax reform and improved composition of public expenditure; more liberal exchange and trade regimes; reforms of the NCBs and SOEs; and addressing problems of economic governance.

10. By the end of the PRGF period, we aim to raise GDP growth to 6.5 percent, up from 5 percent on average during the second half of the 1990s, and to contain inflation to under 4 percent. The external current account deficit is projected to widen, on account of higher capital imports, to slightly above 1 percent of GDP, but would be financeable by a prospective higher level of external assistance on concessional terms. To reduce external vulnerability, gross official reserves are targeted to build up to at least three months of import cover by the end of FY05.

11. Raising economic growth must also be complemented by other pro-poor measures in order for poverty to be meaningfully reduced over the short to medium term. To this end, public resources will be shifted toward poverty reducing areas, particularly to improve access to essential public services such as basic education and health. Over the PRGF period, we will target an overall budget deficit of no more than 5 percent of GDP, and will increase pro-poor spending by at least 2.5 percent of GDP (Table 1). We are committed to pursuing a major revenue effort, on the order of 1.5 percent of GDP over the next three fiscal years. This revenue effort is vital for the budget to adequately support human capital, physical infrastructure, and anti-poverty programs on a sustainable basis without threatening debt sustainability over the medium term. To secure the needed improvement in revenue, we intend to develop a full-fledged tax reform strategy with technical assistance from the Fund in the first PRGF program year.

12. We aim to complete the Poverty Reduction Strategy Paper (PRSP) by December 2004, drawing on the experience in implementing the I-PRSP. In doing so, we will further refine policies in terms of specific time-bound actions, and will assess more fully the budgetary implications of pro-poor measures. Assistance from the World Bank is being sought to set up an interim monitoring arrangement under the I-PRSP.

13. Addressing governance will be critical to implementing this medium-term agenda. This is essential for strengthening the performance of both revenues and the banking system. Moreover, weak governance is viewed as a key impediment to private enterprise and FDI. In light of this, many of the programmed reform measures have been designed to address economic governance problems and build stronger institutions; in this context, we recognize the importance of strengthening law and order so as to improve the investment climate. The approach supported by the PRGF arrangement is focused on improving accountability and transparency in policy—by reducing the scope for bureaucratic discretion—and in the management of public funds. The latter effort is being made with technical assistance under a donor-financed Financial Management Reform Program (FMRP), under which internal controls will be strengthened. Public procurement is also being improved with technical assistance from the World Bank, and imperfections in targeted transfer programs are being tackled. More broadly, we are finalizing a legal framework for establishing an independent Anti-Corruption Commission vested with the authority to investigate allegations of corruption.

IV. Macroeconomic Policies for FY03–04

14. Consistent with this medium-term strategy, real GDP growth in FY04 is targeted to rise to 5.5 percent, inflation to fall to 4.5 percent, and the external current account deficit to widen to slightly above 1 percent of GDP. Growth prospects should improve if agricultural production is at potential and export growth is more robust. These projections are subject to downside risks from higher oil prices and weaker global demand, and we will consult with Fund staff on the appropriate policy response if these risks were to materialize.

A. Fiscal Policy

15. Fiscal performance in FY03 has been positive so far, due to strong revenue collection by the National Board of Revenue (NBR), combined with a significant recovery of tax arrears. However, as a result of the lower-than-expected nontax revenues and overruns in domestic interest payments and retrenchment costs, ADP spending in FY03 will be kept at Tk 173 billion. Furthermore, every effort will be made to maintain the momentum of revenue collections, to attain the budgeted deficit target of 4.2 percent of GDP. Domestic financing will be capped at Tk 56 billion (1.9 percent of GDP), and bank financing for the budget limited to Tk 18 billion. Benchmarks for March and June 2003 have been set in line with these limits (Table 2).

16. Revenue mobilization is the central element of budget strategy for FY04. This will help balance the need to support poverty reduction with the need to contain domestic financing of the budget. It will be aimed at keeping the overall budget deficit at 4.8 percent of GDP, in accordance with the medium-term framework outlined above. Total revenue is targeted to rise by 15 percent (0.5 percentage point of GDP)—with continued strong increases (15 percent) projected for NBR revenue—while expenditure is slated to increase by 17 percent (1.0 percentage point of GDP). To contain the cost of public debt servicing, we will limit domestic financing to 2.0 percent of GDP, and will rely more on external financing on highly concessional terms.

17. If concessional external financing turns out to be higher than the level currently projected, the overall budget deficit could be raised up to 5 percent of GDP, with additional funds to be targeted for poverty reduction and structural reform costs. On the other hand, in view of the uncertain timing of external financing, the budget will be executed prudently. Expenditure will be backloaded, particularly with respect to capital spending. The budget will be kept under review, in consultation with Fund staff. An appropriate course of action will be taken in the event of financing shortfalls. This would include rationalizing and trimming expenditure, and additional revenue measures.

18. At the heart of our medium-term fiscal strategy will be efforts to boost revenues on a sustainable basis to enable substantial progress in meeting the Millennium Development Goals. Emphasis will be given to measures to broaden the tax net and improving tax administration. Revenue measures underpinning the FY04 budget will include: (i) modernizing and expanding the coverage of the Large Taxpayer Unit for income tax; (ii) setting up, and making fully operational, the Central Intelligence Audit and Monitoring Cell for all taxes and covering 1,000 large taxpayers; (iii) revamping the bonded warehouse system (withdrawing warehouse licenses for imports for domestic consumption, and requiring bank guarantees for export-oriented imports); (iv) registering an additional 100,000 new income taxpayers, and around 200,000 new VAT taxpayers; (v) post-auditing of around 20,000 income tax files; and (vi) continued automation of customs and other modernization measures (under the CAM1 project and its integration with ASYCUDA++). These measures, when implemented on a sustained basis, could yield additional revenue of at least 1 percent of GDP per annum. However, in the short-run it would be prudent to assume additional tax revenue of around 0.5 percent of GDP. Moreover, utility prices and administrative fees and charges will be raised on a timely basis to protect nontax revenues.

19. To improve the pro-poor focus of government expenditure, we aim to increase spending for human capital development, health, and social safety nets. Such spending is targeted to rise by at least 1 percentage point of GDP in FY04, primarily reflecting higher maintenance spending for the social sectors and targeted social protection programs, in particular, micro-credit. However, we will examine all possibilities of cutting down on other expenditures, for instance on noninterest and nonwage recurrent expenditures, and will ensure strict discipline on ADP spending, drawing on recommendations of our Expenditure Commission as well as the Public Expenditure Review. Projects to be included in the ADP will be closely scrutinized to ensure best use of available funds. Moreover, within the fiscal year, no new unapproved ADP projects will be added to the program as this could undermine fiscal sustainability and compromise the overall quality of ADP projects. Adequate funding will be ensured to cover the costs of reforming the SOEs and NCBs. Tentative estimates by Fund staff suggest that the costs of reform over the medium term could be in the range of 8 percent to 12 percent of GDP, depending on loan recovery rates in the NCBs and assuming a curtailment of new NPLs and appropriate pricing for energy (see below).

20. As part of our efforts to strengthen governance, particular importance is attached to improving fiscal transparency and control, especially fiscal reporting and watchdog institutions. Recent gains in fiscal reporting will be consolidated through implementing the action plan recommended by the Fund's Fiscal Transparency Module of the Report on Observance of Standards and Codes, as well as meeting key benchmarks under the FMRP. In particular, steps will be taken by the Ministry of Finance to strengthen internal control over expenditure and the office of the Auditor General to better carry out independent audit functions.

B. Monetary and External Policies

21. Monetary policy will need to remain firm in the period ahead to check inflation and control liquidity conditions. Reserve money will be targeted to rise by 5 percent and 10 percent, respectively, in FY03 and FY04, while broad money growth is expected to slow to 12 percent. This should allow BB to rebuild NIR, while accommodating private sector credit growth. To reduce rigidities in the structure of interest rates and to enhance the effectiveness of monetary policy, we have adopted a timetable to apply a formula that links the yields on new issues of national savings certificates (NSCs) to the rates for treasury bills of comparable maturity, to be effective at the latest by December 2003. In addition, we will continue to enhance coordination between foreign exchange and liquidity management operations, drawing on Fund technical assistance.

22. We are committed to a flexible exchange rate management to strengthen the economy's resilience to external shocks and to safeguard competitiveness in a challenging global environment. Intervention in the exchange market will be undertaken only to address disorderly conditions and will be geared to help attain the programmed reserves targets. In this connection, a timetable has been adopted to phase out the existing exchange restrictions under the Fund's Article VIII. In particular, the margin requirements on the opening of letters of credit (LCs) for 55 consumable items and for sugar, rice, and wheat imports will be phased out by November 2003. In addition, by the end of the PRGF arrangement period, we expect to lift the ban on the convertibility and transferability of proceeds on current international transactions on nonresident taka accounts. In addition, we would aim to phase out export surrender requirement and export subsidies in due course.

23. External debt management policy will be prudent in order to maintain debt sustainability. To support the reform agenda, we will rely on grants and external assistance on highly concessional terms and will minimize reliance on contracting or guaranteeing new nonconcessional debt. Specifically, we intend to remain well below the program external debt ceiling, and all new nonconcessional borrowing will be limited to the power and energy, water supply and telecommunications sectors. All projects financed from nonconcessional borrowing will strictly follow guidelines issued by the government on January 15, 2002. Key criteria of these guidelines include: (i) no project will be considered unless concessional resources are not available and (ii) the project must be economically viable and financially self-sustaining. Moreover, given the weak state of the external debt management information system, we have already sought technical assistance to overcome these shortcomings and make the system operational.

V. Structural Policies

24. The structural agenda facing Bangladesh is very large. Given capacity constraints, efforts under the PRGF-supported program will need to sharply focus on the areas that are particularly critical for improving growth prospects and governance, namely tax reform noted above, and NCB and SOE reforms.

A. NCB Reform

25. Recognizing that economic performance has been impeded by poor financial sector governance and the resulting high level of NPLs, we have moved to improve the institutional framework for the supervision of the financial system. Governance and BB supervision of all commercial banks will continue to be strengthened under the recently enhanced prudential framework.

26. Looking ahead, the strategy for banking reform will focus on the NCBs in view of their large NPL ratios (estimated at almost 19 percent of loans net of provisions, or 34 percent on a gross basis). The approach initially will be aimed at curbing the flow of new bad loans, and strengthening governance of NCBs, while developing detailed resolution strategies for each bank. Over the medium term, the goal is for the government to divest these banks—including through privatization in whole or in part. A comprehensive strategy to define the resolution option bank-by-bank and address the existing stock of NPLs will be adopted by April 2004. It will draw on the recommendations of the joint Bank/Fund Financial Sector Assessment Program (FSAP), follow-up technical assistance, and external audits. Implementation of the strategy will also be supported by Bank credit for banking reform to be developed in FY04.

27. In preparation for this comprehensive program, and to signal our commitment to NCB reform, the following additional steps will be taken during the first year of the PRGF-supported program:

• MoF will engage reputable local firms to conduct audits of the four NCBs, based on international auditing and accounting standards. Contracts for these audits will be finalized by August 2003 (structural benchmark).
  
  
• NCBs will be protected from outside interference and their managements made more accountable by strengthening their boards.
  
  
• New professional management will be secured for Agrani Bank by October 31, 2003 (structural benchmark), and management support for Janata and Sonali Banks will be arranged with World Bank technical assistance by December 2003 (structural benchmark). Management will be subject to performance-based criteria, and will be provided with sufficient authority to implement staffing changes at senior levels in order to strengthen bank performance and credit risk management.
  
  
• New net lending by NCBs will be restricted to at most 5 percent during FY04, through: (a) tightening prudential limits on individual loan exposure to 5 percent of paid-up capital; (b) bank-by-bank limits on net lending to continue reducing the market share of these banks; and (c) the requirement that syndication of large loans involve meaningful participation of private banks.
  
  
• BB will develop, in consultation with Fund and Bank staff, interim MOUs with each bank to set net lending limits, including restrictions on specific loans and classes of loans, and will monitor compliance against these limits and restrictions. To ensure achievement of these limits, BB will issue guidelines on best practice in credit risk management.
  
  
• The branch structures of these banks will be further rationalized, including through merger of branches, with the aim of closing a total of 125 out of 3,000 branches by December 2003.
  
  
• Rupali Bank (6 percent of total banking system assets) will be brought to the point of sale in whole or in part by June 2004, following a transparent due diligence process and according to international best practice. An action plan will be adopted by June 2003 to attain this objective.

B. SOE Reform

28. The goals of our SOE reform strategy are to improve SOE efficiency, foster private enterprise, and reduce the fiscal burden of the SOE sector. This strategy is two-pronged:

• Substantially downsize SOEs in the manufacturing sector through a program of closures and privatization. Following the closure of 24 SOEs (mainly in the jute, textile, and paper industries) so far in FY03, an additional 11 SOEs have been slated for closure/privatization by the end of FY03. The government plans to close down or privatize another 105 units over FY04-06, with retrenchment of around 75,500 workers. The overall restructuring cost of this program has been estimated at Tk 64 billion, or 2 percent of GDP, to be absorbed in FY03-06. The Government will strive to reduce the SOE manufacturing sector to the sugar and fertilizer industries by end-FY06.
  
  
• Reforming the energy sector through appropriate pricing and a transparent regulatory framework. Decisive reform of the energy sector is critical to containing SOE losses, since such losses are heavily concentrated in this sector, and to removing impediments to investment. Recent energy price increases have already helped to reduce losses and programs have been instituted, particularly in the power sector, to reduce system losses and raise collections. In the context of the Development Support Credit of the Bank, we have adopted a new petroleum, gas, and power pricing framework to ensure efficiency and financial viability of this sector. This framework provides for a formula-based, flexible pricing mechanism that rationalizes the prices of energy products and enables cost recovery for all incurred operating, maintenance, and capital costs. In addition, an Energy Regulatory Commission Act has been passed to set up an independent body with licensing and pricing authority over the power and gas sectors. With these steps, the efficiency of the sector is expected to improve and losses substantially curtailed.

29. The government has identified all payment arrears, mainly to utility companies, amounting to around Tk 4 billion, which will be cleared by end FY03. In return, the SOEs have committed to servicing a larger share of their debt service arrears to the government. Total SOE arrears at end 2002 amounted to about Tk 145 billion (4.8 percent of GDP). Plans to regularize these arrears will be developed in the context of the energy reform program, with possible external assistance.

C. Trade Reform

30. We are committed to further trade liberalization as a critical means for improving growth prospects. Building on initiatives under FY03, we intend to rationalize the tariff structure by moving to a four-tier tariff rate in FY04, with a maximum rate of 30 percent. The effective average tariff rate will be reduced in tandem with efforts to broaden the customs tax base in order to protect revenue. In addition, under our new five-year export/import regime, expected to be approved by Cabinet in June, the list of goods subject to control (ban, or with quantitative restrictions (QRs)) will be reduced from 134 to around 70. The objective is to keep this list to the minimum, and to confine mainly to QRs for reasons of health, culture, and religion consistent with our WTO commitments.

VI. Financing Requirements and program monitoring

31. The program described above has been developed with strong domestic ownership, based on the track record of the government, and has involved a broad consultative process under the I-PRSP. However, timely implementation will require broad-based support, politically and socially. For this reason, we will make every effort to forge the consensus for the needed reforms, through continued consultations with stakeholders. Moreover, we are attempting to assess the social impact of the reform measures and have put in place initial safety nets to ease the transition for the adversely affected segments of the population. This effort is starting first with the safety net measures for workers affected by SOE restructuring, privatization, and closure, with the assistance of the Bank. Well-designed safety nets will be formulated in due course to support implementation of other structural reforms.

32. Successful implementation of this structural agenda will hinge on sufficient external assistance on highly concessional terms, to complement our own efforts to mobilize domestic resources. The additional external financing need over the PRGF period (FY03-06) is estimated to total $2 billion. We are hopeful that the gap for FY03-04 (estimated at $800 million) could be met by the Development Support Credit ($300 million), further Bank support in FY04, disbursements under the requested PRGF arrangement ($200 million), and additional external support.

33. To enhance the safeguards framework for BB, we are implementing the critical recommendations of the IMF onsite safeguards assessment. In particular, the reserve management functions have been segregated between the dealing room and the back office and a separate middle office function is being developed. Additional efforts will also be made to enhance the mechanism for reserves management, and internal audit will be strengthened with Fund technical assistance. Further, BB's financial accounts are being restated in accordance with International Accounting Standards (IAS), and an audit on International Standards on Auditing (ISA) signed off by an international partner in collaboration with a local accounting firm, will be conducted by the first PRGF review. Moreover, a timetable has been set for adoption by the BB Board of IAS as BB's accounting framework, and the ISA as the auditing standard by FY04.

34. Prior actions will be taken to put the program on a solid footing (Table 3). The program will also be monitored by quantitative, quarterly benchmarks and semi-annual performance criteria, and overall progress will be reviewed on a quarterly basis with the Fund staff. The first PRGF review will be completed by December 2003. It will focus on progress in implementing the FY04 budget and NCB reform, and on initiating tax reforms, and will reach understanding on the performance criteria and benchmarks for the remaining period of the first-year program. The second review will be completed by June 2004. Definitions of aggregates subject to program monitoring and reporting requirements are set out in the Technical Memorandum of Understanding (Annex).

35. Program implementation will be tracked by an inter-agency working group. Efforts will continue to strengthen the monthly reporting system, to ensure the quality and consistency of data used in assessing compliance with the program's quantitative targets. Furthermore, technical assistance will be requested from the Fund in the area of monetary and exchange operations, and tax reform. We will also draw on technical assistance from the World Bank and bilateral donors to strengthen financial management of the public sector and governance.

Table 1. Key Economic Indicators, 2001/02–2007/08

Table 2. Quantitative Performance Criteria and Indicative Benchmarks, March 2003-June 2004

Table 3. Prior Actions and Structural Performance Criteria and Benchmarks under the First Year of the PRGF arrangement

Annex. Technical Memorandum of Understanding

Bangladesh—Technical Memorandum of Understanding

June 4, 2003

This memorandum sets out (i) the definitions for the proposed quantitative performance criteria and benchmarks under the first year of the PRGF-supported program (Table 3 of the Memorandum of Economic and Financial Policies (MEFP)); and (ii) related reporting requirements. The data are to be based mainly on balance sheets of BB and the banking system as compiled by BB Research Department for management.

Item 1:¹ Net domestic assets of Bangladesh Bank (BB) are defined as reserve money minus net international reserves (NIR) of BB valued in taka using the program exchange rates specified in Table 1 below.

Reserve money consists of currency issued by BB (excluding its own holdings) plus government currency held outside the BB plus balances of deposit money banks (DMBs) with BB (excluding foreign exchange clearing accounts) plus balances of other financial institutions with BB.)

NIR is defined in item 4 below.

Item 2: Net domestic financing of central government is defined as the sum of the flow of net bank credit to central government and nonbank claims on central government during the specified period.

Net bank credit to central government is defined as the sum of: (i) BB holdings of government securities and treasury bills; (ii) BB Ways and Means advances to the government; (iii) BB credit to autonomous and semi-autonomous bodies; (iv) government currency liabilities; (v) DMBs holdings of government securities and treasury bills; (vi) DMBs credit to Food Ministry; (vii) DMBs credit to other ministries, autonomous and semi-autonomous bodies; (viii) any other loans, advances and bills discounted extended to central government by the banking system, minus all bank deposits, including lending and onlending accounts, of central government.

Nonbank claims on central government is defined as the sum of: (i) all national savings certificates and related instruments held by nonbank residents, as reported by the National Savings Directorate; (ii) all outstanding U.S. Dollar Premium and Investment Bonds; (iii) all treasury bills and bonds held by nonbank residents, as reported by BB; and (iv) all loans and advances extended by nonbank residents to central government, if any.

Item 3: Net bank borrowing of central government is defined as the change in bank credit to central government as defined above during the specified period.

Item 4: Net international reserves of BB are defined as gross foreign assets of BB (less BB's blocked account with the Central Bank of Iraq) minus international reserve liabilities of BB.

Gross foreign assets of BB consist of its holdings of monetary gold, exchange balances held outside Bangladesh, foreign securities (valued in market prices), foreign bills purchased and discounted, net Fund position and SDR holdings, and the net forward position, if any, of BB. Excluded from gross foreign assets will be: (i) illiquid foreign assets including real property; and (ii) any other foreign assets over which the Bangladesh Bank does not have effective control or which it cannot readily sell, including blocked accounts, pledged, collateralized or other encumbered assets. Also excluded are participation in international financial institutions, holdings of nonconvertible currencies, holdings of precious metals other than monetary gold, and claims in foreign exchange arising from derivative transactions (such as futures, forwards, swaps and options).

International reserve liabilities of BB consist of all foreign currency denominated liabilities of the BB to residents and nonresidents with outstanding maturity up to and including one year, including: (i) Asian Clearing Union debit balances; (ii) all obligations in respect of swap and outright forward transactions; and (iii) any overdue obligations of the central government with respect to foreign debt service. Liabilities also include those arising from balance of payments support borrowing by the Bangladesh Bank, irrespective of maturity, including all liabilities to the Fund.

Item 5: Contracting or guaranteeing of short-term external debt is defined for debt with original maturity of up to one year owed or guaranteed by central government. The term debt is defined as set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), August 24, 2000),² but excludes normal import-related credits, forward contracts, swaps, other future market contracts, and short-term liabilities of the banking system. The definition also includes debt instruments with put options that would be triggered within one year after the contracting date.

Item 6: Contracting or guaranteeing of medium- and long-term nonconcessional external debt is defined as contracting or guaranteeing nonconcessional external debt by central government with an original maturity of more than one year. Nonconcessional debt is defined as borrowing containing a grant element of less than 35 percent. This definition includes not only 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 commitments contracted or guaranteed for which value has not been received. Excluded from this definition are credits extended by the Fund and Asian Development Bank, and U.S. Dollar Premium and Investment Bonds purchased by nonresidents. Debt falling within the limit shall be valued in U.S. dollars at the bilateral exchange rates prevailing at the time of the contract is entered into, or guarantee issued.

The grant element is to be calculated by using the currency-specific discount rates reported by the OECD as Commercial Interest Reference Rates (CIRR) as of the date of contracting or guaranteeing the debt; for maturities of less than 15 years, the grant element will be calculated based on six-month averages of the CIRR, and for maturities of 15 years or longer, the grant element will be calculated based on 10-year CIRR averages. Maturity will be determined based on the original contract.

Item 7: External payments arrears are the stock of overdue payments (interest and principal payments) on short-term debt in convertible currencies with an original maturity of up to and including one year (spot, money market, letters of credit, and others) and medium- and long-term debt contracted or guaranteed by the government (including BB). The limit excludes overdue payments that relate to debts which are subject to rescheduling, or that are in dispute and under discussion with creditors.

* * *

1. For program purposes, any foreign asset, liability or cash flow denominated in a currency other than U.S. dollars shall be converted into U.S. dollars by applying the appropriate end of period exchange rate for March 31, 2003, as published in the Fund's International Financial Statistics (Table 1).

Table 1. Selected End-of-Period Exchange Rates, March 31, 2003
Taka per U.S. dollar	57.90	Indian rupee per U.S. dollar	47.55
SDRs per U.S. dollar	1.3738	Pakistani rupee per U.S. dollar	57.78
Australian dollars per U.S. dollar	1.6567	Swedish kroners per U.S. dollar	8.505
British pounds per U.S. dollar	0.6330	Gold price in U.S. dollars per troy ounce (London PM fixing)	334.85
Canadian dollars per U.S. dollar	1.4693
Euros per U.S. dollar	0.9179
Source: Fund's International Financial Statistics.

2. For the purposes of program monitoring, the following information, including any revisions to historical data, will be provided by BB and Ministry of Finance, or PRGF Monitoring Unit, unless specified otherwise, to the Asia and Pacific Department of the Fund, through the office of the Resident Representative in Dhaka, as set out in Table 3.

3. In accordance with the recommendations of the Safeguards Assessment, the data on the international reserves and balance sheet of BB should be reconciled with the final accounts of BB for each period. Annual data will also be reconciled with the final audited accounts when they become available.

Attachments

Table 2. Bangladesh: Concordance of Program Definitions and Data Sources

Table 3. Bangladesh: Monitoring and Reporting Requirements

(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."

Table 2. Bangladesh: Concordance Between Program Definitions and Data Sources
Item Number	Aggregate			Sources 1	Feb-03  Value 2
				(in billions of taka)
1	Net domestic assets of Bangladesh Bank (BB) = A - 4, converted at program US$/taka exchange rate.				147.8
A	Reserve money				215.1
		Currency outside banks		10G: "Currency outside banks"	160.6
		Reserves		10G: "Deposit Money Banks dep."+"Deposits of cooperative banks"+"deposits of non-scheduled bks"+"priv.sect. dep. non-sched."	54.5
2	Net domestic financing of central government = flow of B plus flow of C				36.2
B	Net bank credit to central government =				189.0
		Claims on central government of banking system			262.8
			Government securities held by BB	10G: " Govt. Securities & T. Bill"+"Special Ad Hoc T. Bills"+"Other Special Ad Hoc T. Bil"+"Govt. Treasury Bond"+"Bangladesh Savings Cert."	89.8
			Government currency liabilities	10G: "Gvt. Curency in Bngladsh Bk."+"Counter Entry for Govt.Cur."	3.4
			Loans and advances to central govt. by BB	10G: "Loans & Adv to Central Govt"+"Govt. Debtor Balances"	0.0
			Advances to auto and semi-autonomous bodies by BB	10G: "Auto & Semi Auto Bodies"	0.6
			Government securities held by DMBs	20G: "Claims on Government: Investment: Govt. Tresry Bills & Sec."	162.9
			Advances to ministries by DMBs	20G: "Bills: Government"+"Advances to Government"	3.1
			Advances to semi-autonomous and autonomous bodies by DMBs	20G: "Bills: Autonomous Bodies"+"Investment: Autonomous Bodies"	3.0
	Minus: Deposits of central government with banking system				73.7
			Government deposits with BB	10G: "Government Deposits"	0.0
			Government lending funds with BB	10G: "Government Lending Funds(1)"+"Government Lending Funds(2)"+Governement Lending Funds(3)"	9.1
			Government deposits with DMBs	20G: "Government Deposits"	59.0
			Government lending fund to DMBs	20G: "Borrow from Govt.On Lend"	5.6
C	Nonbank claims on central government
			National savings certificates (NSCs) held by nonbank residents	Outstanding NSCs reported by National Savings Directorate minus 10G:"Bangladesh Saving Cert." minus 20G:"bang. sanchaya patra" minus 20G:"p.bnd/incom tax bnds"	277.2
			Treasury bills and bonds held by nonbank residents	Outstanding Treasury Securities: Nonbanks	3.3
3	Net bank borrowing of central government = flow of B				5.3
1Italicized references to sources are as follows: 10G - BB Balance Sheet (Form 10G), 20G - Consolidated Balance sheet of DMBs (Form 20G) as reported to Fund's Statistics department. 2Flows are from end-June, 2002.
Table 2 (cont.). Bangladesh: Concordance Between Program Definitions and Data Sources
Item Number	Aggregate			Sources 1	Feb-03  Value 2
				(in millions of US$)
4	Net international reserves = D - E				1,162.6
D	Gross international reserves 3				1,901.9
			Foreign exchange	FAFL: Foreign exchange holdings by currency converted into US$ at program exchange rates	1,858.8
			SDR holdings	IMF Treasurer: SDR holdings converted into US$ at program US$/SDR rate	5.3
			Gold	FAFL: Gold holdings in troy ounces converted into US$ at program gold price.	37.6
			Reserve position with the Fund	IMF Treasurer: reserve position converted into US$ at program US$/SDR rate	0.3
E	International reserve liabilities				739.3
			Use of Fund resources		54.5
			GRA	IMF Treasurer: GRA outstanding converted into US$ at program US$/SDR rate	50.6
			Loans	IMF Treasurer: Loans outstanding converted into US$ at program US$/SDR rate	4.0
			Asian Clearing Union debit balances	FAFL: Asian Clearing Union A/C balance in US$	204.0
			FX clearing accounts	FAFL: FX clearing A/C balances in US$	480.5
			Other liabilities	FAFL: Other foreign A/Cs in US$	0.4
1Italicized references to sources are as follows: FAFL: Foreign Assets and Liabilities of BB; IMF Treasurer: Bangladesh's financial position with the Fund as recorded by Fund's Treasurer's Department. 2Flows are from end-June, 2002. 3Excludes Tk. 0.3 billion blocked account with CB of Iraq.

Table 3. Bangladesh: Monitoring and Reporting Requirements
Item	Reporting Requirement	Periodicity / Reporting Lag
Item 1: Net domestic assets of BB	Balance Sheet of BB (Form 10G), Consolidated Balance Sheet of DMBs (Form 20G), Monetary Survey (Form 30G)	Monthly / within six weeks of end of corresponding period.
Item 2: Net domestic financing of central government	Balance Sheet of BB (Form 10G) Consolidated Balance Sheet of DMBs (Form 20G), Monetary Survey (Form 30G) outstanding stock of national savings certificates, nonbank holdings of government securities	Monthly / within six weeks of end of corresponding period.
Item 3: Net bank borrowing of central government
Item 4: Net international reserves of BB	Foreign Assets and Liabilities of BB	Monthly / within three weeks of end of corresponding period.
Item 5: Contracting of short-term external debt	Contracting or guaranteeing of new external debt by the public sector/government, with details on creditor, amount and terms of each loan	Monthly / within three weeks of end of corresponding period.
Item 6: Contracting or guaranteeing of new medium- and long-term nonconcessional external debt
Item 7: External payments arrears	Level of external payments arrears during period	Monthly / within three weeks of end of corresponding period.