Dominica—Letter of Intent, Memorandum of Economic Policies, and Technical Memorandum of Understanding

Roseau, Dominica
December 10, 2003

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

Dear Mr. Köhler:

1. The letter and memorandum of economic policies (MEP) of June 21, 2003 outline the government's two-stage strategy to solve the complex fiscal and public debt problems facing the country. The first stage consisted of a short-term program of stabilization and financing, in the context of an extended Stand-By Arrangement (SBA). The second stage consisted of a medium-term program, in the context of a successor Fund arrangement, to re-establish the basis for growth and implement a debt strategy to ensure medium-term sustainability.

2. Performance under the first stage of the strategy has been very satisfactory, despite difficult conditions. All performance criteria and benchmarks have been observed since the program was modified last July, including the design of a debt strategy. Accordingly, we request completion of the second review under the SBA.

3. This letter and the attached MEP describe the economic program to be adopted by the Government of Dominica for 2004-06 as part of the second stage of the strategy. The main objective of this program is to restore economic growth by removing impediments to growth, thus reducing unemployment and the level of poverty in the country. The overall strategy is laid out in our Interim Poverty Reduction Strategy Paper (I-PRSP). We are requesting a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) in an amount equivalent to SDR 7.69 million (93.8 percent of quota) in support of the program detailed in the attached memorandum. We intend to cancel the SBA no later than two weeks after completion of this review.

4. Before the above requests are considered by the IMF Board, we will take one fiscal measure, Cabinet will take a policy decision to reduce significantly discretionary tax exemptions, with immediate effect, in an effort to rationalize our tax system. By mid-2004, we will also conduct a review of all statutory and discretionary tax exemptions with a view to assessing their effectiveness and justification, and to prevent abuses.

5. As in the past, the government will maintain a continuous dialogue with the Fund, and stand ready to adopt measures that may be appropriate to achieve the objectives of the program. We will also provide Fund staff with all the relevant information required to complete program reviews and measure performance criteria. The government will abstain from imposing or intensifying exchange and trade restrictions for balance of payments purposes. There will be quarterly performance criteria in the first two years of the arrangement and semi-annual performance criteria in the third year. Reviews under the PRGF arrangement will be completed by mid-March 2004, mid-June 2004 and mid-September 2004 during the first year of the arrangement and semi-annually thereafter. These reviews will be associated with observance of relevant performance criteria. Also, disbursements under the arrangement will be subject to financing assurances reviews in the context of the IMF policy on lending into arrears.

6. We have authorized the Fund to publish this letter, the attached Memorandum of Economic Policies (MEP) and the Interim Poverty Reduction Strategy Paper (I-PRSP), to facilitate a wider access and review of our policies.

Memorandum of Economic Policies of the Government of Dominica

I. Introduction

1. After a difficult start, the government took important steps to bring the program back on track. The Fund-supported program adopted by the government in the summer of 2002 to address the deteriorating economic situation fell short of expectations. Expenditure overruns and tax collection shortfalls derived from a more pronounced economic contraction and external shocks made it difficult to observe the targets under the Stand-By Arrangement (SBA). Most performance criteria for end-December 2002 were not observed. However, after a period of national consultation and a deteriorating outlook, the government decided to strengthen its policies and adopted an austere budget for 2003/04 including a 5 percent wage cut and other fiscal measures equivalent to 2½ percent of GDP.

2. A new two-stage strategy was adopted to deal with the intricate problems confronted by the economy. With economic conditions deteriorating rapidly and the possibility of facing a budgetary financing crisis, the government designed the new strategy. The first stage involved a short-term program with strengthened macroeconomic policies and a refocused structural agenda for the remainder of 2003 to stabilize the economic situation. A key benchmark was the design of a debt strategy to ensure medium-term sustainability. For this purpose, the SBA was extended for six months through February 2004 to give the government time to develop a comprehensive program and a structural reform agenda. The second stage involves the implementation of such a medium-term program with a strong structural component to restore growth and increase employment while simultaneously reducing poverty. To this end, we are requesting a three-year poverty reduction and growth facility (PRGF) from the IMF.

II. Recent Developments

3. The strategy adopted at the last review has worked well and all performance criteria and benchmarks under the program have been observed. Following the approval of the strong budget in early July 2003, and the implementation of a cash management system, the IMF Board completed the first review under the SBA in late July. Subsequently, all performance criteria for end-July and end-September were observed, as were structural benchmarks on: (i) providing Fund staff a debt strategy (end-September); (ii) substituting price controls on fuels by an automatic price adjustment mechanism (end-September); (iii) designing a detailed public sector reform strategy (end-October); and (iv) completing a diagnostic review of the financial system (end-November). These achievements were obtained thanks to better coordination at the government level, and to the effectiveness of the cash management system as a tool in guiding expenditure decisions.

4. There are indications that the economy might have bottomed out. One of the main objectives of the program was to contain the precipitous decline in output. We are glad to report that there are encouraging signs that a recovery might be in sight. The main indicators of this trend are a rebound in tax collections and imports, as well as a modest recovery in tourism and manufacturing production.

5. An ambitious debt strategy has been designed with the objective of regaining medium-term sustainability. The government has reached the conclusion that the current level of public debt at over 110 percent of GDP imposes a heavy burden on the economy and cannot be systematically serviced even if significant additional adjustment efforts were carried out. Against this background, we are seeking a comprehensive debt restructuring that would yield a significant debt reduction in the net present value of outstanding claims and would pave the way to achieving medium-term sustainability. We are mindful of possible fragilities in the financial system, and for this reason, domestic banks are expected to provide only limited support for this operation. We will remain current, to the extent possible, on all current obligations during the restructuring process.

III. Medium-Term Macroeconomic Framework, Structural Reform and Poverty Reduction Strategy

6. The main objective of the medium-term program is to re-establish growth and enable the economy to achieve its full potential by removing all impediments to growth. Following the most severe economic contraction in the history of the country since independence, we aim at regaining the pre-crisis economic growth rate of 2 percent per year. While it would be desirable to achieve an even higher growth rate, we would like to establish realistic targets for the medium term, while laying solid foundations for a more rapid growth in the long run. With a sustained economic recovery and growth, the depressed levels of employment are expected to rise significantly, improving the standard of living and reducing poverty. The results from our recent Poverty Assessment confirms that poverty in Dominica is predominantly associated with unemployment, largely as a result of the decline in the banana industry, and therefore its reduction will require a resumption of growth and the generation of new jobs. Our approach to poverty alleviation is spelled out in the Interim Poverty Reduction Strategy Paper (I-PRSP). We will remain vigilant in ensuring that social spending is safeguarded in the coming budgets as adjustment efforts proceed. Another objective of the program is to significantly reduce the high external current account deficit.

7. The cornerstone of our macroeconomic framework is a significant fiscal effort over the next three years to achieve a primary surplus of 3 percent of GDP. We estimate in our debt strategy that, given the fundamentals of the economy, it is necessary to run a primary surplus of 3 percent of GDP over the medium term. Against the background of an underlying primary deficit (excluding nonrecurrent grants) of about 2 percent of GDP in 2003/04, the fiscal objective of the program would require a fiscal effort of about 5 percent of GDP over the medium term.

8. The structural reform agenda will be cemented on four pillars namely debt, budget, financial and investment climate issues. We have identified these four areas as main structural impediments to growth:

• Debt strategy implementation. A high level of debt discourages investment and growth as it creates economic uncertainty.

• Fiscal reform. The debt problem arose due to a combination of exogenous shocks and inappropriate policy responses. We will endeavor to enact fiscal reform to secure our fiscal objectives and correct previous weaknesses.

• Financial sector strengthening. In order to ensure an efficient allocation of financial resources, the government will seek the assistance of the ECCB to ensure that there is a level playing field among major financial intermediaries.

• Other reforms. There are other impediments to growth that need to be addressed especially in the areas of deregulation and competitiveness, to improve the investment climate in the country.

IV. Macroeconomic Policies for 2004

9. Macroeconomic policies will concentrate on fiscal issues during the program. The current exchange rate peg in the context of the Eastern Caribbean Currency Union (ECCU) limits the role of monetary policy and enhances the role of fiscal policy. The government recognizes the very limited ability of the ECCB to conduct credit operations and to pursue functions of lender of last resort.

10. The government will aim at achieving a primary surplus of ½ percent of GDP in 2004/05. We understand the need to front-load our adjustment efforts to enhance the credibility of our policies and facilitate discussions with our creditors. Achievement of the fiscal target requires an adjustment of 2½ percent of GDP in the budget for 2004/05, or one half of the 5 percent envisaged over the medium term.

11. We will divide the adjustment in 2004 into two phases, one with immediate effect, and the other to be implemented in the upcoming budget. This is for consistency with our budget cycle. We will take one further measure for FY 2003/04 with immediate effect, and other measures will be taken in the context of the 2004/05 budget.

12. The government commits to reducing discretionary tax exemptions before the IMF Board considers this request. Cabinet will take a policy decision to significantly reduce discretionary tax exemptions with immediate effect, with a view to achieve additional tax collections for ½ percent of GDP on an annualized basis. We will also conduct a comprehensive review of all statutory and discretionary tax exemptions to assess their effectiveness and justification by June 2004, and to prevent abuses. This will constitute a structural benchmark under the program. Users of these exemptions will be subject to observance of execution tests to be specified by the government in the context of the review. In order to better monitor these exemptions and to ensure that they are used for intended purposes, the government will require quarterly reports from the users of these statutory exemptions including assessments on execution tests. This is being done in an effort to rationalize our tax system and to improve efficiency of collections. It is difficult to assess the yield of this measure as certain transactions may not take place once the exemption is removed. We will revisit these estimates at the time of the 2004/05 budget.

13. Additional fiscal measures aimed at improving the tax administration and rationalizing expenditures will be introduced in the context of the 2004/05 budget. The remaining measures to achieve our objective of a primary surplus of ½ percent of GDP for 2004/05 will be included in the upcoming budget. Approval of the 2004/05 budget consistent with the program will be a structural performance criteria for end-July 2004. These measures will amount to about 2 percent of GDP, and will include the following:

Expenditure reducing measures. There are four measures amounting to 2.0 percent of GDP.

• Reduction of the wage bill. It is the government's intention to reduce the wage bill by 5 percent in nominal terms by reducing personnel in the 2004/05 budget. This will generate savings of 1.2 percent of GDP on an annual basis.

• Expenditure freeze. The government will not increase noninterest current expenditures in the next budget which will represent a net saving in real terms. This will include a continuation of the hiring and wage freezes. This measure will accrue savings of about 0.4 percent of GDP on an annual basis.

• Increase in retirement age. It is proposed to change the statutory retirement age in the public service from 55 to 60 years to be implemented over a period of four years, beginning in July 2004. The resulting savings in pension payments in 2004/05 and postponement of gratuities amount to 0.2 percent of GDP.

• Revision of vacation and study leave policy. The cost of current policies on vacation and study leave is 0.9 percent of GDP. It is proposed, starting in January 2004, to put measures in place with a view to reducing this cost by 40 percent over two years, resulting in savings in 2004/05 of 0.2 percent of GDP.

Revenue enhancing measures. There is one measure amounting to 0.1 percent of GDP.

• Broadening the tax base for professional license fees. The government will broaden the scope of this tax to other professional activities not currently covered, and will also strengthen the enforcement of the fees charged. We estimate that additional revenues for 0.1 percent of GDP can be obtained.

14. Capital expenditure is expected to be maintained at 7 percent of GDP, but could be reduced if necessary. We estimate that the country can absorb high quality public investment of this amount, which could support our efforts to reinvigorate growth and reduce poverty. Our public sector investment program (PSIP) reflects this objective. However, we are fully committed to our sustainability objective, and will be prepared to make adjustments to the PSIP if this becomes necessary. Capital expenditure will adhere to the approved PSIP, which will be reviewed by the World Bank. Borrowing decisions will continue to be centralized in the Ministry of Finance, which will be involved at an early stage of project planning and borrowing decision-making, especially for externally financed projects.

15. It is expected that the structural reforms would carry short-term costs, but bear long-term benefits. As explained below, some of the structural measures will require additional expenditures such as civil service reform (severance payments). For the purpose of the program, these costs will not count against the primary surplus target, so as to prevent discouraging the adoption of needed structural measures for fear of not observing the fiscal target. However, there is no financing identified for all these reforms and they can only be implemented once adequate financing has been secured. We expect the cost of these reforms to be covered by grants and concessional loans. We also expect that the fiscal adjustment for the second and third year of the program will come mostly from the lasting savings of the structural reforms, most notably the civil service reform.

16. Financing under the program will come mostly from the debt restructuring. It is estimated that even after the significant adjustment adopted in the 2004/05 budget, there will be a financing gap of about US$26 million in 2004 of which the IMF will contribute about US$5 million, and the remaining US$21 million will be covered by the debt restructuring. We estimate that a comprehensive debt restructuring with significant debt reduction in net present value terms is needed to cover the residual financing gaps over the medium term.

V. Structural Reforms

17. The structural agenda will aim at removing impediments to growth and ensuring medium-term sustainability. As already mentioned, the structural policies will be built around four pillars.

A. Debt Strategy Implementation

18. Implementation of the debt strategy will be key to achieving medium-term sustainability. The economy is suffering from debt overhang, as uncertainty about future taxation deters private investment. Growth is unlikely to resume unless the large debt burden is reduced significantly. We have recently announced our intention to approach creditors to seek a debt restructuring that achieves debt sustainability. We committed to pursue a debt restructuring process that is collaborative and to continue, to the extent possible, to remain current on their debt obligations during this process. While discussions with our creditors are likely to be complex, we expect to finalize the debt restructuring during the first quarter of 2004. Rapid implementation of the strategy is important to secure orderly financing under the program.

B. Fiscal Reform

19. The main objective of this reform is to improve the efficiency of fiscal policy and underpin the program's fiscal objectives. There are four main areas of focus:

• Public sector reform. One of the main reasons for the inflexibility of public finances is the relatively large wage bill. We already began the process of reducing wage costs in the 2003/04 budget by reducing wages by 5 percent. We intend to reduce the wage bill by 10 percent over the next two fiscal years mainly through a reduction in the number of positions (with permanent savings of about 2 ½ percent of GDP per year). We plan to reduce the wage bill by 5 percent during the 2004/05 budget, and by an additional 5 percent the following fiscal year. We will build on the work of DFID and the EU to launch this initiative. We will identify the positions that need to be eliminated through the rationalization the public service and secure the necessary financing for this reform. We will conduct a study in March 2004, outlining the process by which this target will be achieved. This will constitute a structural benchmark under the program. We estimate the one-off cost of this reform to be about US$5-6 million (about 2½ percent of GDP). Preliminary estimates indicate that very limited net savings will accrue to the budget during the first year of the reform as the severance payments can be around one year of salaries. However, permanent savings will accrue in the subsequent years of about 2 percent of GDP per annum.

• Tax reform. The main objective is the substitution of the VAT for the consumption tax, the sales tax, the hotel occupancy tax and other minor levies. We will request technical assistance from the IMF and CARTAC for this purpose. We expect the VAT to be in place at the time of the 2005/06 budget. The budget for 2004/05 is expected to include all the preparatory regulations so that the VAT can be introduced with the following budget. Cabinet will approve key parameters like the base, rate, registration threshold, filing frequency and refund system by end-September 2004. This will constitute a structural benchmark under the program. The rate of the VAT will be determined such that it compensates for the taxes that are being eliminated.

• Fiscal institution building. In order to ensure fiscal prudence and improve the transparency of the budgetary process, we will adopt a fiscal responsibility law that articulates the conditions under which deficits or surpluses would be allowed, while ensuring that the debt stock is under control. We will embrace other transparency initiatives in the budget, including publishing of statutory tax concessions and the level of public employment. We will request technical assistance from the IMF and CARTAC for this purpose and expect that this law will be in place by in mid-2005 in time to guide the budget for 2005/06.

• Phased increase in the retirement age. The current retirement age of 55 years is too low by international standards and a heavy burden for an economy with a large aging population (Dominica has one of the highest life expectancies in the world). We will introduce legislation to Parliament by mid-2004 to increase the retirement age for public employees to 60 years in a phased manner. This will constitute a structural benchmark under the program. This will be the first step towards a reform of the pension and social security systems.

• Adoption of a three-year rolling budget. This is a good practice that is followed in an increasing number of countries in the world and requires a medium-term macroeconomic framework. Clarity on future policies would reduce public uncertainty enhancing the prospects for investment. We will request technical assistance from the IMF and DFID and expect that the upcoming 2004/05 budget will adopt this practice.

C. Financial Sector Strengthening

20. We aim at improving the efficiency of the financial system by restructuring state banks and strengthening the supervision of credit unions. While the government will soon have a minority stake in the National Commercial Bank (NCB), we will work with the ECCB in analyzing its portfolio and determining if its capital base remains adequate. We will also review the operations of the Aid Bank to determine the need and scope for restructuring it, with a view to satisfying strategic objectives and performance criteria to be defined by the government. We have requested assistance from the ECCB to review the Aid Bank operations by March 2004, and will develop an action plan by June 2004 with a view to implementation by end-December 2004. We are taking steps to safeguard the financial sector, including credit unions inter alia by assigning responsibility for financial supervision and regulation to the ministry of finance and planning, and by conducting a round of inspections of credit unions with assistance from the ECCB.

21. We will analyze the conclusions of the FSAP mission and will aim at implementing its recommendations. It is expected that the FSAP report will be ready by early 2004. We will review its conclusions and will seek assistance from the ECCB to enhance our structural agenda in this area by adopting FSAP recommendations where appropriate. More specific actions will be announced by the time of the second program review.

22. Implementation of the debt strategy is not expected to modify the balance sheets of the domestic banks in any significant manner. While a restructuring of bank claims on the government will be needed, we will seek to safeguard their capital and portfolio as well as limit the erosion of their profitability. Ultimately, the restructuring is expected to increase the maturity of bank's claims with only limited interest relief.

D. Other Reforms

23. There is an urgent need to improve competitiveness in the economy and reduce external imbalances. Reinvigoration of the export sector will reinforce growth and reduce the large external current account deficit. While it is not easy to achieve these gains in the context of a fixed exchange rate, we believe that an adequate incomes policies together with improvements in the tax system and the regulatory frameworks will improve competitiveness in the economy and help reduce external imbalances. We present, in the matrix of our I-PRSP more detailed measures in this area that we intend to implement during the program. We also intend to embrace further policy recommendations that could emerge from the World Bank regional competitiveness study, where appropriate.

24. The structure and focus of the National Development Corporation (NDC) needs to be clearly defined to improve its effectiveness. Taking into account recommendations contained in various reviews conducted over the years, Cabinet will take a decision on the structure and focus of the NDC with a view to enhancing institutional arrangements for tourism marketing and attracting private investment by end-March 2004.

25. Improving the environment for private investment will be critical for the restoration of growth: A full set of measures will be drawn from the I-PRSP and will be implemented with financial and technical assistance from the international community. These will include: (i) streamlining process/procedures for registering new businesses, to make them fully transparent and minimize the scope for discretion; (ii) improving the regulatory framework for the electricity supply in order to protect consumers and facilitate efficiency gains that would permit lowering of rates over time. This will constitute a structural benchmark under the program; (iii) conducting a cadastral survey and strengthening the registry service so as to accelerate the regulation of property rights and facilitate access to credit by small farmers and other small investors; (iv) revising the land acquisition act to make procedures fully transparent and expedient. We will strive to enhance the investment climate in the economy considerably.

26. We remain fully committed to the program, and will take any additional action that is necessary to ensure that the objectives of the program are achieved.

Dominica—Technical Memorandum of Understanding

1. Dominica's performance under the Stand-By Arrangement and Poverty Reduction and Growth Facility (PRGF), described in the letter of the Government of Dominica dated December 10, 2003, will be assessed by the IMF on the basis of the observance of quantitative performance criteria as well as compliance with structural performance criteria and benchmarks. This Technical Memorandum of Understanding (TMU) sets out and defines the performance criteria (and adjustors), indicative targets, and benchmarks specified in Tables 1 and 2 of the Memorandum of Economic Policies, as well as the monitoring and reporting requirements.

2. The authorities of Dominica are committed to transmit to the Fund staff the best data available. All revisions or expectations thereof shall be promptly reported to the Fund staff.

3. The variables mentioned herein for the purpose of monitoring the performance criteria, which are not explicitly defined, are consistent with the Government Financial Statistics (GFS). For variables omitted from the TMU which are relevant for the program targets, the authorities of Dominica shall consult with the staff on their appropriate treatment, based on GFS principles and Fund program practices.

VI. Fiscal Targets

4. The central government overall balance will be measured from the financing side as the sum of the net domestic borrowing plus net external borrowing. The floor on the overall balance is cumulative from the specified dates.

5. Net domestic borrowing by the central government is the sum of: (i) net domestic bank financing as reported by the consolidated balance sheet of the banking system adjusted for double signature accounts,¹ (ii) net nonbank financing measured by the net changes in holdings of government securities by nonbanks, and net borrowing from nonbank institutions (including special tranches from the ECCB); (iii) the change in the stock of domestic arrears of the central government defined as net changes in unpaid checks issued, unprocessed claims, invoices pending, plus accrued interest payments, and other forms of expenditures recorded above the line but not paid; and (iv) gross receipts from divestment.

6. Net external financing of the central government is defined as the sum of (i) disbursements of project and nonproject loans, including securitization; (ii) proceeds from bond issues abroad; (iii) exceptional financing (rescheduled principle plus interest), net changes in cash deposits held outside the domestic banking system, (iv) net changes in short-term external debt; (v) any change in arrears on external interest payments and other forms of external expenditures recorded above the line but not paid; minus (vi) payments of principal on current maturities for bonds and loans on a due basis and any prepayment of external debt.

The following adjusters will apply:

7. The floor on the overall balance of the central government will be adjusted upward² (downward) to the extent that project loans fall short of (exceed) programmed amounts. This adjustor applies up to June 2004 and will be discontinued thereafter. Project loans are defined as the receipt of loan proceeds to finance the central government's portion of the Public Sector Investment Program. For the purpose of this adjustor, the cumulative project loans amount to: cumulative from March, 31, 2003, US$3.9 million by end-December 2003; cumulative from June, 30, 2003, US$5 million by end-March 2004 and US$6.6 million by end-June 2004. Upward adjustments will not exceed US$5 million by end-December 2003, US$6.35 million by end-March 2004 and US$7.7 million by end-June 2004.

8. The floor on the overall balance of the central government will be adjusted upward² to the extent that budgetary grants exceed programmed amounts. Budgetary grants are defined as grant receipts that are not earmarked for capital outlays. For the period through December 31, 2003, the cumulative programmed amounts are: US$0 million by end-December 2003. Beginning in January 2004, any budgetary grants will be counted as part of revenue if it is used to cover the cost of a specific reform, otherwise the overall balance will be adjusted upwards.

9. The floor on the overall balance of the central government will be adjusted downward by the amount of severance payments or administrative expenditures linked to the debt strategy. It is expected that these costs will be mostly covered by grants, which would also be excluded from the measurement of the overall balance of the central government. In the event of loan financing for this purpose, it will not count toward the measurement of the overall balance of the central government.

10. The central government primary balance will be defined as the central government overall balance (from the financing side as defined in paragraph 4) plus scheduled domestic and external interest payments. Interest payments do not include either domestic or external interest payment made by the central government on behalf of other parties. The floor on the central government primary balance will be cumulative from June 30, 2003.

The following adjusters will apply:

11. The same adjustors described in paragraph 7, 8 and 9 apply to the primary balance.

12. The central government wage bill will be measured as the total expenditure of the central government on wages and salaries of central government employees net of wage refunds, including acting allowances, special duty allowances, responsibility allowances, subsistence allowances, and the employer contribution to Dominica Social Security, but not including retirement benefits, severance payments or other related one-off payments (i.e. accumulated leave). As such, the ceiling does not include wage-related transfers to schools, the National Development Corporation, and local governments. For the period through December 31, 2003, the ceiling on the central government wage bill is cumulative from March 31, 2003. For the period beginning January 1, 2004, the ceiling on the central government wage bill is cumulative from June 30, 2003.

13. Net changes in central government arrears to domestic private parties is defined as the sum of all pending payments by government for goods and services already purchased from these parties, as well as pending interest and amortization obligations on domestic debt held by them. Private domestic parties exclude DOWASCO, Dominica Social Security, National Development Corporation, Dominica Broadcasting Corporation, DEXIA, and the Port Authority. The measure used will be unpaid checks issued and pending invoices for which payment is overdue. The ceiling on net changes of central government payment arrears is cumulative from March 31, 2003. This ceiling will be monitored on a continuous basis through December 31, 2003.

14. Central government revenue is defined as tax collections and nontax revenues reported in the treasury accounts (economic classification), excluding (i) revenues from the economic citizenship program, (ii) foreign and domestic grant receipts, (iii) loan repayments, (iv) wage refunds, and (v) privatization receipts, and includes income tax refunds. For the period through December 31, 2003, the floor on central government revenue is cumulative from March 31, 2003. For the period beginning January 1, 2004, the floor on central government revenue will be cumulative from June 30, 2003.

15. Central government primary savings is measured on an accrual basis (including unpaid checks issued and unprocessed invoices) and is defined as the central government revenue before grants (i.e., excluding grants) minus current non-interest expenditure. For the period through December 31, 2003, the floor on government primary savings is cumulative from March 31, 2003. For the period beginning January 1, 2004, the floor on government primary savings will be cumulative from June 30, 2003. The adjustors described in paragraph 8 and 9 apply to the central government primary savings.

Monitoring Discretionary Tax Exemptions

16. Discretionary tax exemptions are defined as tax exemptions granted under sections 6(2) and 31³ of the Consumption Order Act, Section 26 of the Sales Tax Act, Section 60 of the Customs (Control and Management) Act, Section 25(2) of the Income Tax Act, or remissions of tax under section 109 of the Income Tax Act (except in cases where the Comptroller certifies that the tax to be remitted is uncollectible).

The number of discretionary tax exemptions will be monitored on a continuous basis.

VII. Monetary Targets

17. Net credit of the banking system is defined as in paragraph 5. The banking system is defined as the consolidation of the Eastern Caribbean Central Bank operations in Dominica (including credit extended under the fiscal tranche window), with the accounts of all banks licensed by the ECCB to do business in Dominica as commercial banks.

The following adjusters will apply:

18. For the period through December 31, 2003, the limits on banking system net credit to the central government will be adjusted downward to the extent that net external nonproject financing (i.e., budgetary lending) exceeds US$20.4 million by end-December 2003. For the period through December 31, 2004, the limits on the banking system net credit to the central government will be adjusted upward to the extent that budgetary lending has been obtained and not used for the intended reform.

19. The limits on banking system net credit to the central government will be adjusted upward to the extent that there are temporary shortfalls in external nonproject financing (i.e., budgetary lending) that are outside the control of the authorities. For the period through December 31, 2003, the upward adjustments will not exceed a cumulative US$4.0 million by end-December 2003.

VIII. External Sector Targets

20. Disbursements of nonconcessional external central government and central government guaranteed debt with maturity of at least one year will be monitored by the Accountant General's Office on a monthly basis. Central government and central government guaranteed external debt is defined to include debt contracted or guaranteed by the central government.

21. 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):

"(a) For the purpose of this guideline, the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:

(i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);

(ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and

(iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lesser retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.

(b) Under the definition of debt set out in point 9(a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt."

22. Nonconcessional is defined as debt having a grant element (in net present value relative to face value) of less than 35 percent, based on the currency- and maturity-specific Commercial Reference Rates (CIRR), published monthly by the OECD.⁴ The limit excludes the disbursements of short-term import related debts, the use of Fund resources, refinancing operations, and disbursements of external loans for clearance of payment arrears to DOWASCO.

The following adjusters will apply:

23. The limits on the disbursement of nonconcesssional external loans will be adjusted downward (upward) to the extent that external project loans fall short of (exceed) programmed amounts. External project loans are defined as the receipt of loan proceeds to finance the central government's portion of the PSIP. The cumulative programmed amounts are as follows: cumulative from March, 31, 2003 US$3.9 million by end-December 2003; cumulative from June, 30, 2003, US$5 by end-March 2004 and US$6.6 by end-June 2004. Upward adjustments will not exceed US$5 million by end-December 2003, US$ 6.35 million by end-March 2004 and US$7.7 by end-June 2004.

24. Stock of short-term external debt outstanding is defined as debt with original maturity of less than one year contracted or guaranteed by the 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) (see paragraph 16), but excludes normal import-related credits. This ceiling will be monitored on a continuous basis. The ceiling must not be exceeded at any time. For the period through December 31, 2003, the ceiling on short-term external debt is cumulative from March 31, 2003. For the period beginning January 1, 2004, the ceiling is cumulative from June 30, 2003.

10. Performance Criterion on Nonaccumulation of Central Government and Central Government Guaranteed External Payment Arrears

25. Central government and central government guaranteed external payment arrears are defined as overdue payments on all debt contracted or guaranteed by the central government. The definition of arrears does not include outstanding subscription payments to regional and international organizations for which understandings will be reached to ease payment obligations consistent with the program. For the period through December 31, 2003, the ceiling on the nonaccumulation of central government and central government guaranteed external payment arrears is cumulative from March 31, 2003. This ceiling will be monitored on a continuous basis.

IX. Prior actions, Structural performance criteria, and Structural Benchmarks

Prior Action

26. Government will take a policy decision to reduce significantly discretionary tax exemptions (as defined in paragraph 16 of the TMU). This measure will take immediate effect following the said policy decision prior to the Executive Board consideration of the PRGF Arrangement. This measure is expected to yield ½ percent of GDP on an annual basis.

Structural performance criteria

27. Approval of the 2004/05 budget, consistent with the program, will be a performance criterion for end-July 2004.

Structural benchmarks

28. Divestiture of government shares in the NCB below 50 percent (structural benchmark) means reducing its shareholdings via direct sale of some shares to existing stockholders or to NCB itself to meet this limit. Also, NCB bylaws will have to be amended, consistent with government naming only three of seven directors (or any number of less than 50 percent) (end-December 2003).

29. Civil service reform. Conduct a study outlining the process by which the target of a 5 percent reduction in the wage bill for 2004/05 will be achieved. The study should define the legal basis for the individual payments that will be required for laid off employees as well as an estimate of the cost of this reform (end-March 2004).

30. Tax policy and administration.

• Conduct a review of all statutory tax exemptions with a view to assessing their effectiveness and justification and to prevent abuses (end-June 2004)

• Announce in the budget for 2004/05 the adoption of the VAT by mid-2005. Cabinet approval of key parameters such as the base, rate, registration threshold, filing frequency, and refund system (end-September 2004).

32. Pension reform. Submit legislation to Parliament proposing a phased increase in the retirement age for public employees to 60 years (end-June 2004).

33. Institutional strengthening. Improve the regulatory framework for electricity supply, following the recommendations of technical assistance mission (end-September 2004).

X. Periodic Reporting

34. Regular reporting on a monthly basis (and when possible weekly) will include the following:

• Data for monitoring the program's performance criteria and monthly indicative targets, including

• Fiscal sector

(i) Central government budgetary accounts.

(ii) Dominica Social Security Balance Sheet, showing amounts receivable from central government for contributions and interest.

(iii) Central government domestic debt data.

(iv) Current grant inflows.

(v) Stock of unpaid checks issued and stock of unprocessed claims due and invoices pending.

(vi) Capital expenditure (project by project) and composition of financing, including revised projections for the remainder of the fiscal year.

(vii) Balances in the debt servicing account linked to the Royal Merchant Bank Bond Issue.

(viii) Total number of exemptions issued (by type of exemption).

• Financial sector

(ix) Monetary survey for Dominica as prepared by the Eastern Caribbean Central Bank, including balances in central government double signature accounts

• External and real sectors

(x) Imports and exports data by product.

(xi) Detailed (creditor by creditor) external debt report from the Debt Unit in the Ministry of Finance and Planning, showing fiscal year-to-date disbursements, amortization, interest payments, and outstanding stocks, for the central government, public enterprises and AID-Bank.

(xii) Total disbursements/grant receipts, monthly, disaggregated into: (a) budgetary support (by type-either loans or external "bonds" and/or other securities); (b) project loans; (c) budgetary grants; and (d) project grants.

(xiii) Stock of external payment arrears of the NFPS, including amortization and interest payment arrears, and supplier arrears for the central government, public enterprises, and AID-Bank.

(xiv) Copies of loan agreements for any new loans contracted, including financing involving the issue of government paper, and of any renegotiated agreements on existing loans.

(xv) Consumer price index.

(xvi) Real sector indicators

All information will be reported to Fund staff within three weeks of the end of each month.

35. Reporting on an annual basis will include the following:

• External and real sectors

(xvii) GDP and its components.

(xviii) Balance of payments accounts.

36. Other reporting will include:

• Reports of legislative changes pertaining to economic matters.

² Upward adjustment means lower deficit.

³ As a transitional rule the government might allow exemptions described in Section 31(b) relating to agreements entered into before the date of announcement. The Cabinet's decision should include a decision not to enter into such agreements after the date of announcement.

⁴ For loans with a maturity of at least 15 years, the 10-year average commercial interest reference rates and for loans with shorter maturities, the 6-month average CIRRs, as of November 15, 2003 published by the OECD will be used as the discount rates. To both the 10-year and 6-month averages, the following margins for differing repayment periods will be added: 0.75 percent for repayment periods of less than 15 years; 1 percent for 15-19 years; 1.15 percent for 20-29 years; and 1.25 percent for 30 years or more.