Republic of Lithuania—Letter of Intent, Supplementary Memorandum of Economic Policies, and Technical Memorandum of Understanding

Vilnius, February 7, 2003

Use the free Adobe Acrobat Reader to view the Tables (223 kb PDF file).

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

Dear Mr. Köhler:

1. Lithuania's economic policies aim at promoting sustained economic growth and improved living standards through macroeconomic stability and the further implementation of structural reforms. Lithuania's strategic goal of joining the EU and NATO has been boosted by the invitation to become a member of both in 2004, helping us achieve our policy objectives. The key elements of our economic policy strategy will be to maintain the currency board arrangement as the cornerstone of macroeconomic stability; to continue appropriately prudent fiscal policies in order to avoid external imbalance; and to advance the remaining key structural reforms to promote growth with job creation and greater competitiveness. The attached Supplemental Memorandum of Economic Policies (SMEP) specifies the concrete policy measures to be taken during December 2002--March 2003.

2. In support of the policies detailed in the SMEP, we request completion of the third review of the Stand-by Arrangement with the International Monetary Fund (IMF) that was approved by the IMF Executive Board on August 30, 2001 in an amount equivalent to SDR 86.52 million, and is set to expire on March 29, 2003. The government will continue to maintain its close cooperation with the Fund in the coming years. Given the favorable external position, the government has made an early repurchase of an amount equivalent to SDR 39.2 million (about half of Lithuania's outstanding purchases under an earlier EFF) on January 2, 2003.

3. We believe that the implementation of policies described in the SMEP will achieve the objectives of the program, and we stand ready to take any additional measures that maybe necessary to achieve those objectives. We will consult with the IMF on the adoption of any such measures that may be appropriate, in line with the Fund's policies on consultations.

4. We are committed to transparency in our economic policies, and we authorize the Fund to publish this letter and the SMEP following Executive Board completion of the third program review.

Yours sincerely,

//s// Algirdas Brazauskas Prime Minister

//s// Reinoldijus Sarkinas Chairman of the Board Bank of Lithuania

Supplementary Memorandum of Economic Policies
of The Government and the Bank of Lithuania
for the Period Until March 2003

I. Introduction

1. Following a decade of fruitful co-operation with the IMF, Lithuania stands on the threshold of membership of the European Union (EU). The transformation that has taken place has been remarkable, and Lithuania's economic performance has continued to strengthen over the last eighteen months under the policies supported by the current Stand-By Arrangement (SBA). All major program objectives have been met. Growth has remained robust, despite the ongoing weakness in some major trading partners. Inflation is subdued, and unemployment has fallen significantly in the last year. Steady fiscal consolidation has taken place since 2000, with the budget close to balance over the first three quarters of 2002, and a deficit of about 1.2 percent of GDP for the year as a whole. The repegging of the litas from the dollar to the euro has been a success: spreads are near historic lows, confidence in the currency board arrangement (CBA) remains strong, and foreign direct investment flows are high. The banking system has been strengthened through the implementation of the recommendations of the Financial Sector Assessment Program (FSAP). The privatization process is well advanced and the business environment has been improved. Recent reforms have laid the foundations for continued economic growth in the medium term, and leave Lithuania well placed to reap the potential benefits of EU membership.

2. These successes will not, however, lead to complacency. The government will continue to ensure macroeconomic stability, in particular through the adoption of appropriately prudent fiscal policies. In addition, the government remains committed to continued structural reforms, and especially: the strengthening of the finances of municipalities and the Health Insurance Fund (HIF); improved tax administration; the development of a pension system that will ensure the sustainability of the public finances over the longer term; the completion of the privatization process in a transparent manner; and the creation of an attractive and competitive environment within which businesses, and in particular small- and medium-sized enterprises, can flourish. This combination of macroeconomic stability and ongoing structural reforms will be necessary to ensure sustained growth and further reductions in unemployment in the period up to and following EU accession.

II. The Government's Program

A. Macroeconomic Outlook

3. The economy grew by an estimated 5.9 percent in 2002 (compared to the 4.4 percent previously anticipated) and growth is expected to remain robust in the period leading up to EU accession. The strength of domestic demand relative to external demand coupled with higher oil prices led to a modest widening of the current account deficit to an estimated 5.4 percent of GDP in 2002 and a further increase to 5.8 percent is expected for 2003. This would be financed by sizable capital inflows, including high levels of foreign direct investment largely associated with foreign acquisition of private companies. The appreciation of the litas against the dollar since the repegging on February 2, 2002 is not expected to have a significant adverse impact on competitiveness, given that more than two-thirds of exports are to EU and EU-accession countries. Moreover, productivity growth remains strong and export capacity is likely to benefit from recent investment activity. Against this backdrop, the government believes that its fiscal target for 2003 remains consistent with external sustainability. Nevertheless, it will continue to monitor developments closely, and adapt policies if necessary.

4. Over the medium term, high economic growth rates are crucially dependent on vigorous export growth and cautious domestic demand management. The main risk to the macroeconomic outlook would stem from an unsustainable level of domestic demand that could lead to a sharp widening of the current account deficit and an erosion of competitiveness. Higher oil prices, continued sluggish growth in the EU or higher international interest rates could also lead to such a widening and adversely impact growth. The economy is also reliant on robust FDI inflows to finance the current account deficit, and any reduction in these inflows would result in higher gross external financing requirements, and eventually a slowdown in growth.

B. The Currency Board Arrangement

5. Maintaining the credibility of the CBA continues to be the cornerstone of the economic policy framework. The government and the Bank of Lithuania (BoL) believe that the CBA in its present form should be preserved until accession to ERM2 and the adoption of the euro at the earliest possible date.

6. The growth of money and credit reached 16.9 and 30.4 percent, respectively, in 2002, reflecting strong economic growth, low interest rates, and a more aggressive lending strategy by banks operating in a competitive environment. Brisk credit growth is also expected in 2003, although at a slower pace. While these developments also reflect a gradual convergence toward the higher levels of monetization and credit found in other advanced transition countries, the BoL remains mindful of the potential risks to loan quality associated with rapid credit growth, and will continue its efforts to strengthen banking supervision. In view of the ample liquidity in the banking system, there is a risk of overheating, and the BoL intends to maintain the required reserve ratio at 6 percent for the foreseeable future, although its ultimate objective is to align it with lower ECB levels and institute the remuneration of required reserves over the medium term.

C. Fiscal Policy

7. Preliminary below-the-line results show that the general government budget deficit in 2002 was 1.2 percent of GDP, below the program target of 1.5 percent, even with full implementation of capital expenditures and net lending. Over the first three quarters of 2002, it was close to balance. Current expenditures ran significantly below budget, but were likely to have increased in the fourth quarter as appropriation managers brought expenditure closer into line with budget plans. Some shortfall in tax revenue from VAT and excise taxes was also expected during the last quarter, related to the timing of some changes in these taxes. Capital expenditure was higher than expected due to additional EU-related projects and a virtually full implementation rate.

8. The budget for 2003, approved by Seimas on December 10, 2002, targets a fiscal deficit of 2.0 percent of GDP (equivalent to a deficit of 1.3 percent of GDP using the 2002 program definition and adjustors described in the Technical Memorandum of Understanding). This target would represent some easing of the fiscal position relative to the outcome for 2002. The government believes this is unavoidable due to significant additional EU-related expenditures of about LTL 335 million (0.6 percent of GDP), comprising LTL 35 million for co-financing, and LTL 300 million for administrative capacity building and investment. The changes to the personal income tax (PIT) are likely to prove somewhat more costly (LTL 40 million) than had initially been anticipated, while the decisions to postpone the corporate income tax (CIT) declaration to October and not to introduce a real estate tax (RET) in 2003 will cost LTL 90 million and LTL 70 million, respectively. While higher indirect taxation will provide additional revenue of LTL 120 million, the government recognizes the need to limit current expenditure on non-EU-related programs, which is thus set to grow by less than GDP. The financing strategy remains unchanged and involves €150 million of net proceeds from eurobonds with remaining financing to come from domestic markets, in accordance with the objective of moving gradually towards longer maturities and a greater share of domestic securities.

9. Fiscal policy will respond appropriately to changes in the macroeconomic outlook. In the event of an unsustainable increase in the current account deficit, the government stands ready to tighten fiscal policy as necessary to ensure external sustainability. In addition, if growth is significantly higher than expected in 2003, the automatic stabilizers will be allowed to operate in full. Despite the temporary weakening in the fiscal position in 2003 and 2004 associated with the costs of EU accession, the government remains committed to moving towards a structurally balanced budget over the medium term. In particular, 2004 will be extremely challenging, due to the expected expenditure pressures associated with the initial year of EU membership. Given the need to contain the deficit, there will be little room for outlays for the savings and land restitution programs, let alone new subsidies such as the Housing Saving Scheme. In any case, the government is determined not to allow spending pressures to derail the fiscal consolidation process, as it believes that maintaining strong fiscal discipline over the coming years will be crucial to support participation in ERM2 and enable Lithuania to fulfill the prospective obligations of EMU membership.

D. Structural Policies

Fiscal Structural Reforms

10. The main components of the tax reform package have now been completed. The new PIT law, which was passed in July 2002 and became effective on January 1, 2003, increases the tax exempt minimum to LTL 290 per month and is estimated to result in a higher than previously expected cost of about LTL 320 million in 2003. This adds to the estimated cost of about LTL 60 million associated with the new VAT law. These costs are partially offset by the gains of about LTL 120 million from higher excises on cigarettes and diesel, gains of about LTL 110 million from the new CIT law, gains of about LTL 40 million from improvements in tax administration, and the reinstatement of the capital gains tax as of January 1, 2003. The tax reform package therefore implies a net cost of about LTL 110 million in 2003. Given the need to finance the increase in additional EU-related expenditure, the government recognizes the necessity of stopping the decline in the ratio of tax revenue to GDP. Hence, the government is committed to not awarding new preferential tax treatments to specific sectors in the coming years, to re-examining existing treatments, and to improving tax administration.

11. The overall financial situation of municipalities improved somewhat in 2002. The stock of arrears went down by LTL 30 million in the six months to end-September 2002 and municipalities are likely to show a combined fiscal surplus for the year. These positive developments were supported by a number of measures, including: a legal amendment to the 2002 budget making state budget transfers for clearance of arrears conditional on municipal arrears being reduced by at least the amount of the previous transfers; the publication in the media of the arrears of all municipalities; the establishment of a commission to monitor municipal decision making; and expenditure reviews broadly along the lines proposed by the World Bank study. While the overall situation has improved, a number of municipalities show persistent weaknesses. The central government will not support external borrowing by municipalities or an increase of borrowing limits. Only in the case of Birzai Rural Municipality, which is reducing arrears, was the borrowing limit increased to finance an environmental project. The 2003 budget law allows for borrowing only by those municipalities that are constantly reducing their arrears. The government is also considering making approval of EU financing of municipal projects conditional on reduction of arrears. The government intends to submit to Seimas a draft RET law in 2003 for implementation in 2004. This law will constitute an important first step in providing municipalities with control over their tax base, allowing municipal councils the right to set tax rates.

12. In order to improve the finances of the HIF, a number of cost saving measures were introduced from March 2002. These measures included the introduction of patients' medication booklets to improve control; a reduction in the number of fully compensated medications from 40 to 9; a reduction in the margins applicable to wholesalers; the introduction of prescription limits for health service providers; and negotiations with pharmaceutical companies leading to a reduction in the price of 60 drugs by an average of 19 percent. This was, however, insufficient to compensate for large cost overruns on pharmaceuticals in the first quarter. In 2003, the government will take additional steps to ensure that the HIF is in balance, eliminating the need for new special transfers from the state budget. To this end, legislation is being prepared limiting the price of compensated prescription medicines to no more than 5 percent higher than the lowest price in the EU (saving LTL 10-15 million). In addition, in March 2003 the compensation of a number of medicines will be reduced from 100 percent to 90 percent (saving LTL 10 million). Full implementation of all the measures by mid-2003 would reduce costs by about LTL 120 million, allowing for the elimination of all arrears by end-2003. The government also intends to develop a long-term plan for hospital restructuring.

13. The Law on the Pension System Reform was passed by Seimas in December 2002, introducing a voluntary defined-contribution second pillar from the beginning of 2004. This new accumulative pillar will be financed by diverting part of the state social insurance contributions of those who elect to participate in it. The size of the pension contribution will be 2.5 percentage points in 2004, rising to 3.5 percentage points in 2005, 4.5 percentage points in 2006, and 5.5 percentage points in 2007. Due to the reform, the State Social Insurance Scheme would lose from 20 to 60 million litas of revenue in 2004 depending on the number of participants in the new pension system, and the cost would be expected to rise in line with the increase in the size of pension contributions. The new system is less costly and ambitious than earlier proposals, but by itself does not ensure the sustainability of public finances over the longer term as the population continues to age. The government and the relevant supervisory authorities will ensure that adequate oversight arrangements for the new pension funds are in put place before the new second pillar becomes effective.

Financial Sector

14. The government and Bank of Lithuania (BoL) will continue to strengthen the financial sector along the lines recommended in the FSAP and EU peer review (April 2002) in a number of areas. First, in the area of supervision of credit institutions, in addition to already amended rules on large exposures controlling connected lending, the BoL will bring the rules on loan provisioning into line with best international practices. To strengthen the legal protection for banking supervision staff, an amendment to the BoL Law will be submitted to Seimas in early 2003. A co-operation agreement with the Swedish regulatory authorities is being finalized. Second, in the area of anti-money laundering (AML) and combating the financing of terrorism, in addition to strengthened AML practices in insurance and capital markets, staffing and training are being upgraded in the newly reorganized Financial Crime Investigation Service (FCIS). The BoL has also updated its training for supervisors to include new "Know Your Customer" rules, and by end-March 2003, the government will introduce further amendments to comply with EU directives by widening the coverage of agencies and businesses that must report on financial transactions. Third, to strengthen the payments system, the government and BoL are drafting the Law on Amendments of the Law on Payments and the Law on Settlement Finality in Payment and Securities Systems, which they plan to submit to Seimas in 2003. The Law on Payments will regulate the relations between the credit institutions and their clients in making payments, and the Law on Settlement Finality in Payment and Securities Systems will regulate the settlement systems, rights and duties of the participants of the systems. The Bank of Lithuania is supposed to perform the supervision of the systems. Finally, in the insurance regulation area, amendments to the existing law on Insurance were passed by Seimas on May 23, 2002, which put in place FSAP recommendations concerning corporate governance, consumer rights and auditing until two new laws, the law on Insurance Activity and the law on Insurance Contracts, are approved by Seimas in 2003.

Other Structural Reforms

15. Unemployment has continued to decline from a peak of 13.2 percent in March 2001, but remains high (10.9 percent in December 2002). With the recent introduction of a differentiated minimum wage, limits on wage indexation, simplification of dismissal procedures, and reduction of severance payments, the labor market is becoming even more flexible. The high unemployment rate and persistent regional disparities result mainly from skill mismatches and lack of regional mobility, as well as from insufficient job creation in the private sector. In that connection, the government is committed to further improving the business environment, in particular reducing excessive bureaucratic procedures, improving the legal framework, and facilitating the activities of small and medium-sized enterprises.

16. Privatization, especially in the energy sector, has proceeded more slowly than expected. Protracted negotiations with Gazprom continue on the privatization of Lithuanian Gas (34 percent of shares), and in the event a deal is not reached the government will need to seek a new buyer. Negotiations also continue with Gazprom on privatization of the power plant in Kaunas. Tender procedures for the privatization of two distribution companies, successors of the Lithuania Power Company, will start in 2003, to be completed by year-end.

17. The government concluded its enlargement negotiations at the European Council in Copenhagen in December 2002, and is expected to join the European Union on May 1, 2004, subject to parliamentary approval followed by a referendum. Lithuania would only be required to pay two thirds of the annual contribution in 2004, but would be eligible for grants for the entire year. Consequently, contributions would amount to about 0.8 percent of GDP in 2004, and 1.2 percent in 2005. Grants would amount to approximately 0.8 percent of GDP in 2003, rising to 2.7 percent in 2004, and 4.1 percent in 2005. In agriculture, direct income support for farmers would be provided at 25 percent of the EU level. This would be increased by 5 percent every year until 2006, and then provided at 100 percent of the EU level by 2013. Finally, it has been agreed that the first unit at the Ignalina power plant would be closed by 2005, followed by the closing of the second unit in 2009. The EU would finance the dismantling costs and partly finance the costs of alternative energy sources.

III. Program Issues

18. The current SBA (equivalent to SDR 86.52 million), which Lithuania has treated as precautionary, is set to expire on March 29, 2003. Progress in implementation of the program continued to be monitored through quantitative performance criteria and benchmarks for end-December 2002 and structural policy benchmarks for end-2002 and 2003 (presented in the attached tables). The third review by the IMF Executive Board is scheduled to take place at the end of February, 2003. The definitions of the program targets remain as those established in the Technical Memorandum of Understanding (Annex). The government will continue to maintain its close cooperation with the Fund in the coming years. Lithuania made an early repurchase of an amount equivalent to SDR 39.2 million (about half of the outstanding purchases under an earlier EFF) on January 2, 2003.

Table 1. Lithuania: Performance Criteria for Stand-By Arrangement, 2001–021
			Target		Adjusted Target	Outcome2
Continuous performance criteria
I.	Exchange rate
	LTL 3.4528 per euro 3		. . .		. . .	Observed through December 31, 2002
II.	100-percent coverage of currency board liabilities, in percent		100		. . .	Observed through December 31, 2002
III.	Reserve requirements, in percent					Observed through December 31, 2002
	Reserve requirements through
	June 30, 2002		6
	Reserve requirements from       July 1, 20024		4
IV.	Non-accumulation of new external payments arrears		. . .		. . .	Observed through December 31, 2002
Quantitative performance criteria
I.	Ceiling on the general government deficit, mln. LTL
Cumulative from January 1, 2001
	March 31, 2001 (previous arrangement)		271		287		91
	June 30, 2001		460		496		337
	September 30, 2001		600		689		546
	December 31, 2001		841		1011		932
Cumulative from January 1, 2002
	March 31, 2002		383		412		103
	June 30, 2002		564		642		72
	September 30, 2002		764		886		-11
	December 31, 2002		776		. . .		603
II.	Floors on net foreign exchange coverage of the currency board arrangement
Stocks
	September 30, 2001, US$ mln.		-127		. . .		2
	December 31, 2001, US$ mln.		-127		. . .		11
	March 31, 2002, euro mln.		-147		. . .		23
	June 30, 2002, euro, mln.		-147		. . .		21
	September 30, 2002, euro, mln.		-147		. . .		36
	December 31, 2002, euro, mln.		-147		. . .		49
		All maturities		1-5 year maturity		All maturities			1-5 year maturity
		(medium- and long-term)
III.	Ceilings on contracted public and publicly guaranteed medium- and long-term external debt; mln. US$
Cumulative from January 1, 2001
	March 31, 2001 (previous arrangement)	293		200		183			0
	June 30, 2001	433		200		183			0
	September 30, 2001	648		200		194			0
	December 31, 2001	683		200		250			0
Cumulative from January 1, 2002
	March 31, 2002	450		200		35			34
	June 30, 2002	610		200		472			0
	September 30, 2002	640		200		501			0
	December 31, 2002	640		200		515			35
IV.	Ceilings on the outstanding stock of public and publicly guaranteed short-term external debt; mln. US$
Maximum stock during the period
	March 31, 2001 (previous arrangement)		0		. . .		0
	June 30, 2001		50		. . .		3
	September 30, 2001		50		. . .		3
	December 31, 2001		50		. . .		3
	March 31, 2002		200		. . .		37
	June 30, 2002		200		. . .		3
	September 30, 2002		200		. . .		3
	December 31, 2002		200		. . .		. . .
Source: Lithuanian authorities; and Fund staff estimates.
1Definitions and exclusions are presented in the Technical Memorandum of Understanding.
2Based on latest available data. The figures for the cumulative fiscal deficit outcome have been revised from the previous staff report (EBS/02105) but remain below the program targets.
3This performance criterion was modified on February 2, 2002 consistent with TMU paragraph 2.
4This is consistent with the statutorily imposed required reserve ratio of 6 percent, because, pursuant to paragraph 5 of the TMU, the required reserve ratio envisaged under the program allows for a 2 percentage point variation from the statutorily imposed required reserve ratio.

Table 2 Lithuania: Quantitative Benchmarks for Stand-By Arrangement, 2001–02
			Ceiling	Outcome
I.	Domestic guarantees, mln. LTL
	Outstanding stock
		March 31, 2001 (previous arrangement)	319	217
		September 30, 2001	314	232
		December 31, 2001	312	247
		March 31, 2002	315	197
		June 30, 2002	312	210
		September 30, 2002	312	214
		December 31, 2002	312	216
II.	Central government arrears, mln. LTL
	Outstanding stock
		March 31, 2001 (previous arrangement)	0	19
		September 30, 2001	0	37
		December 31, 20011	0	0
		March 31, 2002	0	6
		June 30, 2002	0	44
		September 30, 2002	0	60
		December 31, 2002	0	. . .
Source: Ministry of Finance; and Fund staff estimates. 1A government decision to clear pharmaceutical arrears was considered as clearance of arrearsunder the program.

Table 3. Lithuania: Structural Benchmarks for Stand-By Arrangement, 2001–02
Measure		Date	Status
Submit to Seimas draft amendments to the Law on Revenue Redistribution of Municipalities		end-September 2001	Observed
Submit to Seimas draft amendments to the Privatization Law for establishing the Reserve Stabilization Fund		end-September 2001	Observed
Tender for privatizing the Agricultural Bank		end-September 2001	Observed
Government's decision on a set of measures to overhaul municipal finances		end-December 2001	Observed
Submit to Seimas draft amendments to the Law on Social Securityneeded for the pension reform		end-December 2001	Observed, but supplemented with another benchmark(Pension reform concept)
Submit to Seimas a Pension Reform Concept		end-December 2001	Observed
Submit to Seimas legal amendments on accounting standards		end-December 2001	Observed
Submit to Seimas a new labor code		end-December 2001	Observed
Submit to Seimas draft CIT and VAT		end-December 2001	Observed
Submit to Seimas draft PIT law		end-January 2002	Observed with delay (submitted in May)
Submit to Seimas amendments to the law on Tax Administration and law on Social Security on the merger of the SoDra's payroll tax collection unit with STI		end-January 2002	Observed
Finalize quarterly plan for arrears reduction of municipalities		end-March 2002	Observed
Submit to Seimas the new Real Estate Tax law		end-September 2002	Delayed. Submission now expected in 2003
Submit to Seimas amendments to the CIT law to return the declaration date from October 2003 to May 20031		end-September 2002	Observed
Submit to Seimas amendments to the law on the State and Municipalities budget for 2002 to make transfers for clearance of arrears conditional on the reduction of the stock of arrears by municipalities		end-September 2002	Observed
Submit to Seimas the draft unemployment insurance law2		end-December 2002	Delayed. Submission now expected in mid-2003
Source: Lithuanian authorities.
1Not discussed by Seimas.
2The current timing is as agreed in SMEP from EBS/02105

 

Technical Memorandum of Understanding
for the 2001-2003 Stand-By Arrangement

1. This Memorandum defines variables that constitute quantitative performance criteria and benchmarks for the stand-by arrangement and sets out the reporting requirements for the government and the Bank of Lithuania.

I. Performance Criteria on the Operation of the Currency Board Arrangement

Maintenance of exchange rate under currency arrangement

2. The present exchange rate of LTL 3.4528 per €1 will be maintained throughout the period of the program. The currency of the peg was changed on February 2, 2002. In this connection, all performance criteria related to the currency board arrangement were adjusted accordingly at the time of the repegging.

Cover for currency board arrangement

3. The Bank of Lithuania will ensure the maintenance of not less than 100 percent foreign reserve backing for the Bank of Lithuania's liabilities, as defined in paragraph 4 below under the currency board arrangement for the duration of the stand-by arrangement.

4. Foreign reserves backing will consist of the gross foreign reserves of the Bank of Lithuania, as defined in paragraph 10, expressed in Litai at the official exchange rates of the Bank of Lithuania. The Bank of Lithuania's Litai liabilities under the currency board arrangement comprise:

(i) Litas notes and coins in circulation

(ii) correspondent accounts of and certificates of deposit and other Litas liabilities to commercial banks and nonbank financial institutions;

(iii) government deposits;

(iv) staff and other private sector deposits;

(v) correspondent accounts of foreign central banks.

Required reserves of the banking system

5. Average reserve deposits of the banking system over each required reserve holding period established by the Bank of Lithuania (running from the 24^th of one month to the 23^rd of the next month) shall not be permitted to be below required reserve deposits of the banking system, as defined in paragraph 6, by more than 2 percentage points of eligible liabilities, as defined in paragraph 6.

6. All banks will be required to hold reserve deposits on account with the Bank of Lithuania of not less than 6 percent of their domestic and foreign currency deposit liabilities. Together, these shall constitute the required reserve deposits of the banking system. The deposit aggregates against which required reserves of the banking system shall be calculated will be referred to as "eligible liabilities," as defined in the March 14, 2002 Resolution No. 38 of the Board of the Bank of Lithuania ("Regulations on Reserve Requirements for Credit Institutions"). Average reserve deposits of the banking system for each reserve maintenance period will be calculated at the end of each holding period as a percentage of eligible commercial bank liabilities.

7. The Bank of Lithuania will extend new credits to banks only and in amounts that do not violate (i) the performance criterion requiring full foreign currency backing for currency board liabilities or (ii) the performance criterion specifying the minimum targets for net international reserves.

Performance criterion on floor on net foreign exchange coverage of the currency board arrangement

8. International reserve assets and liabilities shall be valued in euros using the Bank of Lithuania's official rates prevailing at each test date. For the period of the program, monetary gold will be valued at market prices according to BoL internal guidelines.

9. Net foreign exchange coverage of the currency board arrangement is defined as:

(i) gross foreign reserves of the Bank of Lithuania, less foreign reserve liabilities;

less

(i) foreign currency-denominated liabilities of the Bank of Lithuania to domestic residents and privatization proceeds of the government held in the Bank of

Lithuania; and

(ii) Litai liabilities of the Bank of Lithuania, as defined in paragraph 4, under the currency board arrangement, less deposits withdrawn through deposit auctions and any central bank bills.¹

10. Gross foreign reserves of the Bank of Lithuania shall be defined as:

(i) monetary gold holdings;

(ii) holdings of SDRs;

(iii) reserve position in the IMF; and

(iv) holdings of foreign exchange in convertible currencies by the Bank of Lithuania.

11. Excluded from gross foreign reserves are:

(i) capital subscriptions to foreign financial institutions;

(ii) long-term nonfinancial assets of the Bank of Lithuania;

(iii) convertible currency-denominated claims on domestic banks;

(iv) assets in nonconvertible currencies; and

(v) foreign assets pledged as collateral or otherwise encumbered.

12. Fund staff will be informed of details of any gold sales, purchases, or swap and derivative operations during the program period, and any resulting changes in the level of gross foreign reserves that arise from revaluation of gold carried out according to the accounting practice of the Bank of Lithuania will be excluded from gross reserves as measured herein.

13. Foreign currency-denominated reserve liabilities of the Bank of Lithuania shall be defined as:

(i) the Bank of Lithuania's convertible foreign currency liabilities to nonresidents, with an original maturity of up to and including one year;

(ii) the outstanding use of Fund credit.

14. Excluded from foreign reserve liabilities are any liabilities arising from balance of payments support loans of maturity longer than one year, including such loans from the EU, the BIS or other international financial institutions, foreign governments or foreign banks.

15. Foreign currency-denominated liabilities to domestic residents shall include convertible currency deposits of the general government, and liabilities to banks and non-bank financial institutions, including deposits under the reserve requirement. Bank of Lithuania Litai liabilities under the currency board arrangement are defined in paragraph 4.

II. Performance Criteria on General Government Fiscal Balance, Guarantees for Domestic Borrowing, and Arrears

16. The general government encompasses the national government (comprising the state and municipal governments) and the extrabudgetary funds. The extrabudgetary funds include the Social Insurance Fund (SoDra), Health Insurance Fund, Privatization Fund, Ignalina Closure and Decommissioning Fund, and any other extra-budgetary operations (as of January 1, 2002, the Road Fund was included in the state budget). The central government is defined as the general government excluding municipalities.

17. The general government deficit is determined on a cash basis.

• The overall deficit is the excess of total expenditure plus net lending over total revenue and grants. For the purpose of program monitoring, it is defined as the negative sum of (i) net domestic financing; (ii) net external financing and (iii)  net privatization receipts (Table 1).

• Net external financing is the sum in national currency of (i) the disbursements of external loans (to the entities covered above the line or on-lent by the general government, including but not limited to budgetary organization and appropriation managers); (ii) exceptional financing (rescheduled principal plus interest if any); (iii) proceeds from bonds or other debt-related instruments issued abroad; less: (iv) amortization due (including but not limited to amortization payments of appropriation managers and budgetary organizations, and total repurchases under IMF arrangements comprising those directly serviced by the government and those on-lent to the BoL and other entities-the counter entries of the latter two items are reflected in repayments under net lending); and (v) changes in assets held for liquidity and/ or investment purposes outside the domestic banking system.

• Net domestic financing is the sum of net bank financing and net nonbank financing.

  • Net bank financing is defined as the change in the banking system's claims on the general government in domestic and foreign currency, including the change in the holdings of government securities by the banking system; minus the change in balances held in the central bank and the commercial banks and other banking institutions.

  • Net nonbank domestic financing is defined as the sum of: (i) the change in the holdings of government securities by nonbanks, calculated as the difference between the change in the stock of government securities and the change in the holdings of government securities by the banking system; (ii) any net direct borrowing from nonbank institutions, including by budgetary organization and appropriation managers.

• Net privatization proceeds are defined as the cash receipts from asset sales by the general government from abroad or domestically minus privatization-related expenditure. Expenditures necessary for, and directly related to, the privatization of state-owned enterprises shall be deducted from gross privatization proceeds and will not be classified as expenditure above the line in the fiscal accounts. These are limited to (i) outlays for consultants and advisers, (ii) increases in authorized capital prior to the sale of an enterprise, and (iii) outlays due to assuming the clean-up of environmental damages as identified in specific privatization agreements.

18. The ceiling on the general government deficit is subject to two adjusters for 2001 and 2002: for faster-than-projected implementation of net lending operations and for faster-than-projected implementation of investment projects by budgetary organizations and appropriation managers. No adjustors apply for 2003.

19. For the purpose of assessing the observance of the ceilings on the general government fiscal balance in 2001 and 2002, the program targets will be adjusted upwards by the amount actually disbursed and on-lent under already committed foreign loans from International Financial Institutions (including the World Bank, the EBRD, the EIB, and the NIB) and other sources of financing as specified in Table 2 are higher than the amounts assumed under the program with a 50 percent implementation rate of the total annual commitment.

20. The implementation of general government investment projects carried out by budgetary organizations and appropriation managers, including but not limited to the Ministry of Defense and excluding Road Fund investment, is specified in Table 3 on a quarterly institution-by-institution basis. The performance criterion on the fiscal deficit will be adjusted in 2001 and 2002 by the amount equal to the excess of the actual appropriations over the programmed cumulative quarterly amount for every project, assuming a 50 percent implementation rate of the total annual commitment. The adjusted amount for every project for each test date shall not exceed the annual appropriation for each project based on a 100 percent implementation rate.

21. General government guarantees on domestic borrowing include all guarantee commitments for (i) borrowing in domestic currency from residents and nonresidents and (ii) borrowing in foreign currency issued for the Agricultural Marketing Agency and the Export and Import Credit Insurance Agency (Table 4).

22. Outstanding payment obligations of the general government include all identified obligations incurred by the state government, municipalities, SoDra, the Health Insurance Fund, and other extrabudgetary funds as covered by the definition of general government provided above. Outstanding payment obligations are defined as delayed payments for deliveries of goods and services when a bill has been received but not paid after 45 days. For wages and salaries, and pensions, outstanding payment obligations are defined to exist when payments are delayed by more than 7 days. Outstanding payments obligations of the central government are defined as outstanding payments obligations of the general government minus outstanding payments obligations of the municipalities outside the general government (Table 5).

III. Performance Criteria on External Debt

Ceiling on contracting or guaranteeing of external debt (i.e., debt denominated in foreign currency) with original maturities of more than one year by the public sector with a sub-ceiling on external debt with original maturities of longer than one year and including five years.

23. For purposes of this performance criterion, the public sector comprises: (i) general government (as defined in paragraph 16), (ii) the Bank of Lithuania, and (iii) other agencies on behalf of the general government (Table 6). This performance criterion applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted by the Executive Board on August 24, 2000 (Decision No. 12274-(00/85) but also to commitments contracted or guaranteed for which value has not been received. Excluded from the limits are use of IMF resources, guarantees of foreign currency-denominated borrowing of the Agricultural Marketing Agency and the Export and Import Credit Insurance Agency covered in paragraph 21, and foreign currency direct borrowing and guarantee by the municipalities from resident banks which are not guaranteed by the central government. Included are other than IMF balance of payments support from official creditors.

Ceiling on the outstanding stock of external debt (i.e., debt denominated in foreign currency) with original maturities of up to and including one year owed or guaranteed by the public sector.

24. For purposes of this performance criterion, the public sector excludes the Bank of Lithuania. The term debt has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 by the Executive Board (Decision No. 12274-(00/85). Excluded are normal import-related credits, liabilities on the correspondent accounts with central banks of the BRO (Baltics, Russia, and other countries of the former Soviet Union) countries, guarantees of foreign currency-denominated borrowing of the Agricultural Marketing Agency and the Export and Import Credit Insurance Agency covered under paragraph 21, and foreign currency direct borrowing and guarantee by the municipalities from resident banks which are not guaranteed by the central government.

25. The general government will not accumulate external payments arrears on any expenditure item or external debt as defined paragraph 23-24. Transactions subject to the ceilings specified in Section III shall be valued in the contracted currency and converted into U.S. dollars at the time the loan agreement is entered into at the exchange rate for the end of the month.

IV. Reporting

26. The authorities will provide the IMF with information needed to monitor the implementation of the program on a regular basis and in accordance with the timetable indicated below. Fund staff will review together with the authorities the data reporting on an ongoing basis and revise the reporting whenever necessary.

Information on money and banking

27. On a monthly basis, the Bank of Lithuania will provide information on:

• international reserves;

• the balance sheet of the Bank of Lithuania, deposit money banks, other banking institutions, and the consolidated banking survey;

• the structure of bank assets and liabilities;

• the currency exchange between the Bank of Lithuania, commercial banks, and the general government.

28. In line with SDDS requirements, the data on international reserves of the Bank of Lithuania will be provided to the Fund on the 5^th working day after the end of the month at the latest; the balance sheet of the Bank of Lithuania will be provided to the Fund on the 10^th working day after the end of the month at the latest throughout the program period in the agreed format. The other data referred to in paragraph 27 will be provided to the Fund on the 18^th working day after the end of each month at the latest throughout the program period in the agreed format.

General government budget implementation and financing

29. On a monthly basis, the Ministry of Finance will provide information on:

• below the line financing of the consolidated general government;

• revenue of the national government (state government and municipalities);

• on-lending operations of the general government to the nongovernment sector;

• revenue and expenditure of all extrabudgetary funds included in the calculation of the general government financial balance;

• outstanding domestic government debt broken down by maturity and type of debt (direct and guaranteed), including disbursements and redemption;

• domestic debt service;

• use of resources borrowed abroad;

• general government deposits held abroad;

• disbursements and repayments of foreign loans;

• borrowing by municipal governments;

• domestic guarantees issued during the month and the stock of outstanding domestic guarantees at the end of the month (Table 3); and

• the stock of outstanding payment obligations of the general government, broken down by state government, municipalities, the Social Insurance Fund, the Health Insurance Fund, and each of the other extrabudgetary funds (Table 4).²

30. These data will be reported to the Fund within 30 days after the end of each month throughout the program period in the agreed format.

31. On a quarterly basis, the Ministry of Finance will provide information on:

• state government revenues and expenditures in terms of both economic and functional classification; and

• local government revenues and expenditures in terms of both economic and functional classification.

32. For the state government, these data will be reported to the Fund within 30 days after the end of the quarter throughout the program period in the agreed format. Data for municipalities will be reported to the Fund within 90 days after the end of the quarter throughout the program period in the agreed format.

Information on the External Sector

33. On an monthly basis, the Ministry of Finance and the Bank of Lithuania will provide information on:³

• short-term and long-term external debt stock of the public and private sector⁴ including non-concessional loans from multilateral organizations; and

• external debt service for short-term and long-term external debt of the public sector.

34. These data will be reported to the Fund within 30 days after the end of each month throughout the program period in the agreed format.

35. The above reporting requirements will be assessed on an ongoing basis, and may be revised at the initiative of the Fund and with the consent of the government and the Bank of Lithuania.

February 7, 2003

//s// Ms. A. Ungulaitiene Secretary Ministry of Finance

//s// Mr. A. Kregzde Vice Governor Bank of Lithuania