Former Yugoslav Republic of Macedonia—Letter of Intent, Supplementary Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

September 29, 2003

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

Dear Mr. Köhler:

On April 30, 2003, the Executive Board approved a Stand-by Arrangement (SBA) (EBS/03/51, 4/16/03) for the Republic of Macedonia. The attached Supplementary Memorandum of Economic and Financial Policies (SMEFP) describes our performance to date under the program with the Fund and the policies that the Government of the Republic of Macedonia will implement during the remainder of 2003 and in the first quarter of 2004. We believe that the policies set forth in our MEFP and the attached SMEFP are adequate to achieve the objectives of its program, but we will take any further measures that may become appropriate for this purpose. We will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in our MEFP and SMEFP, in accordance with Fund policies on such consultation.

The program remains on track. All the end-June 2003 performance criteria (PCs) and most of the indicative targets were observed, the one exception being the indicative target on Health Insurance Fund (HIF) payments arrears. The single structural performance criterion and three of the four structural benchmarks were observed; the exception was the structural benchmark on audit of procurement procedures at the HIF, which was initiated with a one month delay.

Since our program is on track and in light of the policies described in the SMEFP, we request completion of the first review under the SBA and waivers of applicability with respect to those September 30, 2003 quantitative performance criteria for which data will not be available by the time of the Executive Board meeting scheduled for October 17, 2003. We are confident that all September 30, 2003 quantitative performance criteria will be met.

Supplementary Memorandum of Economic and Financial Policies

I. Introduction

1. This Supplementary Memorandum of Economic and Financial Policies (SMEFP) describes the government's economic program from July 2003 to March 2004, under the Stand-By Arrangement (SBA) that was approved by the Executive Board of the International Monetary Fund on April 30, 2003. It supplements the original MEFP of April 15, 2003, particularly in the areas of banking sector governance and supervision, drawing on the recommendations of the FSAP mission. It also reflects understandings on the revised budget for the remainder of 2003 and incorporates new commitments to improve public sector management.

2. Macroeconomic developments remain generally favorable, but there is little evidence of a decisive turnaround in economic performance or of a diffusion of growth across all sectors of the economy.

• Real GDP growth for the last quarter of 2002 (4.3 percent y-o-y) and the first quarter of 2003 (2.2 percent y-o-y) are consistent with a year-end turnaround. Increased activity for the rest of the year is likely to be supported by a strong growth in the metals sector, a continuing political stabilization and a pickup in government spending. However, a positive trend in industrial production in the first half of 2003 was concentrated in few sectors of the economy and dependent on the performance of a small number of companies.

• The CPI inflation rate has slowed in the first half of the year and reached 0.7 percent (y-o-y) in June 2003. The low inflation reflects a dip in food prices, the strong euro and the expiry of the financial transactions tax.

• In the external sector, the weak US dollar reduced the competitiveness of the textile sector, but total exports grew strongly nonetheless, owing to a brisk growth in steel and other metals exports. Despite this, the trade balance deteriorated somewhat in the first half of the year. This reflected some increase in imports for processing, but mainly one-time factors. On aggregate, competitiveness indicators have not changed significantly. Consequently, an improvement in the trade balance is expected in the second half of the year.

3. The fiscal stance, which had been highly expansionary in the second half of 2002, turned markedly tighter in the first half of 2003. First half central government spending was lower than projected — by about 1.3 percent of annual GDP — reflecting a late approval of the 2003 budget, the implementation of new procedures for strengthening fiscal discipline and public expenditure transparency, and a slow startup of capital spending after a review of projects pared their number. Taking into account larger than expected non-tax revenues, the central government deficit in the first half was about 1.5 percent of annual GDP lower than projected.

4. Easing monetary conditions provided an offsetting shift in the policy mix while the overall fiscal tightening reduced the pressure on the foreign exchange market. As a result, net international reserves remained above program floors. The fiscal tightening, and a return of confidence in the denar, also contributed to a welcome decline in the interest rate on central bank bills from 15 percent to 7 percent during February-April. Commercial banks' deposit and lending rates declined by less (only two percentage points) and with some lag, reflecting weak competition and persistent structural problems in the bank lending market.

5. Broad money grew approximately in line with the program assumptions, but the shift toward foreign currency deposits continued. In spite of the tight fiscal policy, demand for money remained strong, due in part to the abolition of the financial transactions tax. The demand for denar deposits did not strengthen as much as anticipated, however, because changes in the denar-euro interest rate spread spurred an increase in the demand for foreign currency deposits. An additional factor may be the new foreign exchange law, which allows exporters to retain their foreign exchange proceeds indefinitely. The strengthening of money demand resulted in somewhat higher than anticipated credit to the private sector.

6. We have undertaken a number of reforms to improve the financial position of the state electricity company (ESM). The price of electricity per kilowatt-hour in each category of electricity consumption was raised by 7 percent on July 1, 2003 thus passing through about half of the increase in the VAT charged on electricity. In addition, we initiated a reduction of some 1050 non-essential personnel, which should generate savings of approximately 60 million denars in 2003. We are ready to take further measures, if necessary, to ensure the financial health of ESM on the eve of its privatization.

7. We have begun to address the poor fiscal performance at the Health Insurance Fund. The positive list for medicines was rationalized, and we have allowed participation of international pharmaceutical suppliers within a transparent procurement process. The financial system audit report by the State Audit Office (SAO) will be presented to Parliament by January 2004. The terms of reference for the international auditor was agreed with the World Bank, which should allow the completion of the full systems audit of the Health Fund by end-2003 in cooperation with the SAO.

8. Parliament has enacted a package of amendments to the banking laws, improving the banking environment and bank supervision. Several of the modifications were in response to FSAP mission recommendations. The amendments to the foreign exchange law substantially liberalized foreign currency lending, which should alleviate credit constraints in the economy. The new central bank law, inter alia, affirmed the NBRM's mandate to set exchange rate policy, allowed the Governor of the central bank to propose vice governors of the NBRM, and strengthened accountability. Three new vice governors have been appointed, ending a long standing impasse. In addition, with a goal of improving banking supervision, the threshold for central bank approval of changes to shareholding structure was lowered, "fit and proper" provisions were strengthened, information sharing between supervisory agencies was improved and the range of corrective measures expanded and made more consistent.

9. We have concluded bilateral agreements with all Paris Club creditors and Kuwait, cleared all technical arrears, and included the resulting current obligations in our debt service schedule.

II. Policies for the Remainder of 2003 and 2004

A. Macroeconomic Policy Framework

10. Although the absence of broad-based growth highlights a risk to our macroeconomic projections, we see our program objectives as achievable. Slightly slower than expected growth in the first half of the year has led us to refine our growth forecast for 2003 from about 3 percent to 2¾ percent. Moreover, pending further analysis, we now anticipate GDP growth in the range of 3 to 4 percent in 2004. The inflation forecast for 2003 has been reduced by 1¼ percentage point to 1¾ percent, while 2004 inflation is likely to be within a range of 2½ to 3 percent. The external current account deficit (excluding official grants) is expected to improve to about 8.5 percent of GDP in 2003 from 11.3 percent in 2002 and to improve further to 8.2 percent in 2004. If, however, growth fails to materialize or the external position deteriorates, we stand ready to modify our policies accordingly.

11. In line with the revised macroeconomic outlook and reflecting our proposed supplementary budget for 2003 (described below), we have updated our financial program (Table 1) and the technical memorandum of understanding (Appendix V). The program continues to be anchored by the need to bring the fiscal position to a sustainable level and by our intention to keep the stock of gross official foreign exchange reserves at about four months of imports.

12. Our fiscal overperformance during the first half of the year (equivalent to about 1½ percent of GDP) has led to a revision of fiscal and monetary policies during the second half. We recognize that an effort to reach the original annual expenditure ceilings after the underspending in the first half of the year would generate sharp reversals in the fiscal impulse — an upswing in the second half of 2003 followed by a downswing in 2004. We have therefore decided to hold central government recurrent spending for the year to a level that is ¼ of a percent of GDP lower than stipulated in the original budget. At the same time, in light of a significant backlog of important public investment projects, we will make an effort to keep capital spending for the year at the originally budgeted level. This will entail a significant acceleration — capital spending in the second half of the year will be four times the amount in the first half-but we note that spending in the first half was slowed by a late adoption of the budget and by our undertaking a review aimed at eliminating low-priority projects.

13. For the year as a whole, aggregate revenue collection is expected to be broadly in line with projections except for higher than anticipated receipts of dividends from the telecommunications company. This apparently healthy revenue position does not lead to complacency, however. The composition of revenues and weaknesses in the areas of VAT collection and excises are cause for concern. In addition, a large stock of VAT refund arrears (around 1 billion denars, the equivalent of about two months of refunds) is placing a burden on exporters and risks undermining compliance. We have therefore undertaken to reduce rapidly the stock of VAT refund arrears claims from denar 966 million at end-June 2003 to denar 866 million at end-September 2003 and denar 366 million at end-December 2003, by end-March 2004 all VAT refund arrears will be cleared. Consequently, tax revenues in 2003 will be slightly lower than had been programmed.

14. The revision of our revenue and expenditure policies will lead to a central government deficit slightly smaller than had been programmed: 1.4 percent of GDP instead of 1.6 percent. Given that the position in the first half of the year was nearly balanced, and that the main source of budget finance is the treasury deposit at the central bank, this will result in a large swing in central bank credit to the government. This expansion in the NBRM's net domestic assets could compromise compliance with the foreign exchange reserves targets under the program. The NBRM and the government recognize that, in order to ensure that these targets are met, it may be necessary for the NBRM to raise interest rates in the second half of the year. The size of any required increase is difficult to assess at this point. Nevertheless the NBRM is committed to using all available instruments, including raising of interest rates as much as necessary to ensure that program commitments will be met.

B. Public Sector Reforms

15. We will take measures to improve VAT collection. The stocks of VAT payment arrears increased in 2003 creating uncertainty about VAT collection. We will define a collectable stock of VAT payment arrears, and take necessary steps to begin the collection process. In addition, the financial police unit will investigate financial crimes, including tax fraud (in cooperation with PRO) and money laundering. The internal control department of the PRO will be strengthened by the addition of qualified staff and a program of system audits will be defined and implemented by end December 2003 (structural benchmark).

16. We will continue to take measures to improve public expenditure management and further develop treasury operations. In accordance with IMF recommendations in this area, we will make efforts to rebalance reform efforts between treasury operations, which have improved considerably, and budget preparation, which remains cumbersome. The Agricultural and Water Funds will be closed and their revenues and expenditures will be integrated into the central government budget, starting with the 2004 fiscal year. The 2004 budget presentation will be improved by eliminating excess detail and including a summary of central and general government budgets. Furthermore, we will seek ways to improve cash management including financial planning, debt management (treasury bills and other debt management issues), commitment controls, and consolidation of extra budgetary funds (EBF) accounts within the treasury single account (TSA).

17. We will take steps to improve the fiscal position of the social funds. In this regard, we will strengthen the collection of contributions to the Pension, Health and Employment Funds through more vigorous administration. In particular, we will enhance the exchange of information between the funds and the PRO. We will also carry out joint audits by the funds and the PRO starting end-September 2003. On the cost side, we will impose strict adherence to rules governing spending by the funds. In order to strengthen the control of pension and benefit costs and improve our ability to forecast benefit entitlements, we will implement the September 2001 amendment to the Pension and Disability Law which provides for indexation on the CPI (80 percent weight) and wages (20 percent weight).

18. To address the long-standing problem of social contribution arrears, we have put in place a framework for clearing arrears on an installment plan. Legislation will be changed by end-2003 to provide for the application of a market rate of interest on arrears in social contributions to reduce moral hazard as is the case with late payments of tax liabilities. Structural and legal measures to strengthen collection will be taken by the end of the year.

19. Reform in the health sector has lagged behind expectations and we are committed to bring reforms back on track. By end-2003, in line with program commitments, arrears to suppliers will be reduced to the end-2002 level. In addition, as a prior action of the program, notification letters of redundancy will be sent out to 900 employees of the health sector. Most of these have been identified through a voluntary separation program. As a structural benchmark, notification letters will also be sent to another 340 employees by end-March 2004. In order to lock in the reduction (by at least 1,240) in the number of positions while maintaining the quality of health care, we will accelerate the restructuring of the health sector in line with the World Bank's technical assistance in the framework of the Health and Social Protection Project. In particular, we will prepare — by end-March 2004 — revised organizational charts which allow for the reduction in the number of positions in health institutions and any needed reallocations of personnel (structural benchmark). We will complete all local tenders for all positive list drugs by end-November, 2003 and have the pharmaceuticals advisor in place at the HIF by end-October, 2003 to assist in preparing international tenders which will be announced by end-2003. Based on the results of the ongoing audits, we will improve the financial procedures in the HIF. Further efficiency gains will come from better management of medical supplies. Taken together, all these measures should enable the HIF to cover its current costs without government transfers starting in 2004. Over the medium-term, we see major cost cutting potential by privatizing state owned providers of medical services. As a first step, the law with be amended to prepare for the privatization of pharmacies and dentistries by end-2003. In addition, we are discussing with the World Bank a comprehensive project which includes a reform of HIF management and a contracting system for hospitals.

20. With the assistance of the IMF, we are continuing to work on the development of government securities market and ways to strengthen our public debt management. A fully functioning Treasuries market will need to be in place by early-2004, in order to allow the MoF and NBRM to manage public debt and liquidity and develop the capacity to issue domestic and foreign currency securities. The law on the budget has been amended to allow the government to borrow on the bond market and the law on securities may need to be amended to allow the stock exchange to list short term government paper. Regulatory changes will also be undertaken to introduce OTC trading. We have requested technical assistance from the IMF — a short term resident adviser — to strengthen the Debt Management Unit within the MoF. We intend to make a first bill issue by January 2004.

21. We remain firmly committed to the principles of fiscal decentralization as envisaged in the Ohrid Peace Framework Agreement. While the process of devolving fiscal responsibilities and powers to the municipal level is difficult and complex, we intend to accelerate preparations — along the lines of previous IMF advice on phased implementation — before the next municipal elections in 2004. To speed the process, we have sought additional IMF technical assistance on the drafting of the Law on Local Government Financing (LLGF) which will be submitted to Parliament in time to be passed before the end of 2003, on the phasing of decentralization, and on measures which could be implemented at an early stage to help develop administrative capacity at the local level.

22. We remain committed to eliminating all non-strategic commodities from the strategic reserves and to the full liberalization of the tobacco market. Currently, the strategic commodity reserve fund contains 166 types of commodities. A new law on strategic reserves will be submitted to Parliament by end-2003. The new law will define the strategic reserves on the basis of four or five WTO-compliant commodities. Meanwhile, we continue to sell non-essential stocks and will complete the program of sales in line with the new law by end-March 2004. In the tobacco market, a complex system of loan guarantees and monopoly purchasing arrangements has distorted market incentives and hindered market performance. To address these problems, we will draft a new Tobacco Law that, among other things, allows any company, domestic or foreign to purchase and market tobacco in Macedonia. The law will be enacted by end-November 2003 in time for the next tobacco purchasing season (structural benchmark). Public resources will no longer be used to provide collateral or loan guarantees for tobacco marketing or related operations.

C. Monetary Framework and Banking Sector

23. In the face of progressive euroization of deposit money banks' balance sheets, we will continue to strengthen banking supervision. In this context, the bank supervision department of the NBRM will require more detailed reporting on banks' assets and liabilities, including breakdowns by currency, currency indexation, maturity and sector. The first report, covering end-December 2003, will be completed by end-March 2004 and system-wide data will be provided to the Fund on a regular basis from that date. By end-September, 2003, the department will also require each commercial bank to submit a description of its procedures to assess customers' exchange rate risks. The on-site supervision manual will be revised to include the exchange rate risk exposure of bank borrowers in the banks' credit risk assessment by end-December 2003 (performance criterion). Supervisors will receive training to assess these risks.

24. Furthermore, we will introduce legislation to improve governance and strengthen supervision of financial institutions. A structural benchmark will be the submission to Parliament by end-December 2003 of legislation giving the NBRM the authority to license and supervise money transfer houses. A new legislative framework shall also be drafted to license and supervise savings houses.

25. Amendments to the anti-money laundering law will be proposed (or a new law will be drafted) in line with the FSAP mission recommendations and implementation of the law will be expedited. The amendments will criminalize terrorist financing. Supervisory authorities will be given a substantive role in implementing the law and imposing sanctions. These amendments will be submitted to Parliament by end-September 2003.

26. Appropriate legislative and administrative measures will be taken to ensure that NBRM is not put in the position of appearing to adjudicate disputes relating to payment guarantees among banks and their clients. By end-December 2003, the Ministries of Finance and Justice and NBRM will make a joint proposal on a mechanism to facilitate quick resolution of the disputes by the courts.

D. Program Monitoring and Data Reconciliation Issues

27. We have set up a joint MoF-NBRM working group, with detailed terms of reference to reconcile fiscal and monetary data on a monthly basis. As a prior action for completion of the review, the working group will prepare and submit to the Fund a report on the reconciliation of July 2003 data, that includes an analysis of any discrepancy and recommendations on measures to reduce the discrepancy in the future.

28. We will continue to work on improving our national income statistics and data analysis. The lack of good quality data on quarterly national income accounts continues to hamper our ability to analyze and project economic behavior in Macedonia. In order to rectify this situation, we will request IMF technical assistance to the Statistical Office of Macedonia that will focus on improving quarterly national income accounting methodology and expenditures approach to GDP calculation. In addition, the NBRM will prepare an inflation forecast on a regular basis.

29. In line with the recommendations made in the Safeguards Assessment, we have taken the requisite measures to strengthen the NBRM's reporting system. We now monitor monetary aggregates using a constant exchange rate methodology instead of the previously used stock-flow methodology. The end-2002 NBRM accounts used for the reporting to the IMF have been reconciled with the NBRM's financial accounts that were certified by the external auditor. We have also published the 2002 NBRM annual report.

Technical Memorandum of Understanding

This memorandum defines the variables subject to the quantitative targets (performance, criteria and indicative benchmarks), established in the Supplementary Memorandum of Economic and Financial Policies (SMEFP) and describes the methods to be used in assessing the program performance with respect to these targets.

A. Definition of the General Government

1. For the purpose of this TMU, the term "general government" covers: central government as defined in the Annual Budget Document (including Agency for Stock Reserves and courts), Agricultural Fund, Employment Fund, Health Insurance Fund, Pension Insurance Fund, Road Fund, Bank Restructuring Agency (BRA), Privatization Agency and other funds, agencies and institutions that are currently treated by the Ministry of Finance as part of government and which correspond to the classification followed by the National Bank of the Republic of Macedonia (NBRM) in their monthly submissions to the Fund of balance sheets of the central bank and the consolidated accounts of the commercial banks. The authorities will inform the Fund staff of any new funds, or other special budgetary and extrabudgetary programs that may be created during the program period to carry out operations of a fiscal nature as defined in the IMF's Manual on Government Financial Statistics, and will ensure that these will be incorporated within the definition of consolidated general government.

B. Net International Reserves of the NBRM

2. Net international reserves (NIR) of the NBRM are defined as the difference between NBRM's reserve assets and its reserve liabilities.

3. Reserve assets are defined as liquid and usable foreign convertible currency claims on nonresidents plus monetary gold. Alongside monetary gold, reserve assets of NBRM include SDRs, foreign currency cash, securities, deposits abroad, and the reserve position at the Fund. Excluded from reserve assets are any assets that are frozen, pledged, used as collateral, or otherwise encumbered, claims in foreign exchange arising from transactions in derivative assets (futures, forwards, swaps, and options), and precious metals other than gold.

4. Reserve liabilities are defined as all foreign exchange liabilities of the NBRM to nonresidents and residents, including all credit outstanding from the Fund, arrears on principal or interest payments to commercial banks, suppliers, or official export credit agencies, and future and contingent commitments to sell foreign exchange arising from transactions in derivative assets (futures, forwards, swaps, and options). General government's foreign exchange deposits at the NBRM are excluded from reserve liabilities.

5. At end-December 2002, reserve assets so defined stood at US$734.6 million; reserve liabilities so defined stood at US$80.8 million (including US$11.3 million in foreign exchange liabilities to residents); and NIR so defined stood at US$653.9 million. General government's foreign exchange deposits at the NBRM stood at US$134 million (Table 1).

6. Quarterly floors (NIR floors) have been established for the cumulative changes in the NIR of the NBRM from the level at end-December 2002 (Table 1 of the SMEFP). The changes in the NIR will be measured in U.S. dollars excluding valuation effects calculated according to the methodology described in Section J.

Adjustors

7. The NIR floors are set based on the assumption that the balance of payments financing will amount on a cumulative basis, from end-December 2002 to:

The balance of payments financing is defined as gross disbursement of foreign loans or grants to the general government or the NBRM for balance of payments support minus payments, to the creditors with whom bilateral agreements are yet to be signed, of debt service due and technical arrears on the deferred April 1999-March 2000 maturities. Excluded from this definition are the project loans and grants, and purchases from the IMF (Table 2).

8. If balance of payments financing exceeds (falls short of) the baseline assumed in ¶7, the NIR floors of the NBRM will be adjusted upward (downward) to the same extent, with the proviso that the downward adjustment to the target will not exceed the equivalent of US$40 million on a cumulative basis.

9. The NIR floors will be adjusted downward by the amount of any prepayment of external debt and will be adjusted upward for any privatization proceeds or lump-sum proceeds from concession fees in foreign currency, and restitution of foreign assets of the former SFRY as a result of succession proceedings which amounted to US$17.8 million in April 2003.

10. The NIR floors will be adjusted upward and to the same extent, if general government's foreign exchange deposits at the NBRM exceed their end-2002 level for reasons other than the gross disbursement of balance of payments financing (¶7). In addition, the NIR floors will be adjusted upward and to the same extent, if the cumulative decline in frozen, encumbered and pledged assets of the NBRM exceeds the following baseline:

C. Net Domestic Assets of the NBRM

11. Net domestic assets (NDA) of the NBRM are defined as reserve money minus the net foreign assets (NFA) of the NBRM.

12. Reserve money is defined as currency in circulation (outside banks), vault cash of banks, and required and excess reserve deposits of banks in denars and in foreign currency held at the NBRM or at the NBRM accounts abroad.

13. Net foreign assets (NFA) of the NBRM are defined as reserve assets plus those foreign assets of the NBRM that are excluded from reserve assets under the definition in ¶3 of this TMU, minus foreign exchange liabilities of the NBRM to nonresidents.

14. At end-December 2002, reserve money so defined stood at denar 18,175 million; NFA so defined stood at US$714.2 million or denar 43,177 million (converted using the stock flow valuation methodology described in Section J); and NDA so defined stood at denar -25,002 million. At constant exchange rates (converted using the valuation methodology described in Section J), NFA so defined stood at denar 42,074 million and NDA at denar - 23,899 million

15. Quarterly ceilings (ceilings for NDA) have been established for the cumulative changes in the NDA of the NBRM from the level at end-December 2002 (Table 1 of the SMEFP).

Adjustors

16. If balance of payments financing exceeds (falls short of) the programmed levels shown above (in ¶7), the ceilings for NDA of the NBRM will be adjusted downward (upward) to the same extent, with the proviso that the upward adjustment will not exceed the denar equivalent of US$40 million on a cumulative basis.

17. The ceilings for NDA of the NBRM will be adjusted upward by the amount of any prepayment of external debt and will be adjusted downward for any privatization proceeds or lump sum proceeds from concession fees in domestic and foreign currency, and restitution of foreign assets of the former SFRY as a result of succession proceedings. Proceeds from the sale of government flats will be excluded from this adjustment.

D. Net Domestic Assets of the Banking System

18. Net domestic assets (NDA) of the banking system, which includes the NBRM and the deposit money banks, are defined as broad money (M3) minus the net foreign assets (NFA) of the banking system.

19. Broad money (M3) includes currency in circulation, demand deposits, quasi-deposits, and non-monetary deposits (time deposits over 12 months and restricted deposits) of the non-government, and government deposits held at domestic money banks. Quasi and non-monetary deposits include deposits denominated in denar and in foreign currency.

20. NFA of the banking system are defined as the banking system's foreign assets minus foreign liabilities.

21. At end-December 2002, broad money so defined stood at denar 72,834 million; NFA of the banking system so defined stood at denar 63,249 million; and NDA of the banking system so defined stood at denar 9,585 million (converted using the stock flow valuation methodology described in Section J). At constant exchange rates (converted using the valuation methodology described in Section J), broad money stood at denar 72,072; and NDA of the banking system at denar 9,295 million.

22. Quarterly indicative ceilings have been established for the cumulative changes in the NDA of the banking system from the level at end-December 2002 (Table 1 of the SMEFP).

Adjustors

23. The ceilings on the NDA of the banking system will be subject to the same adjustors as the ceilings on the NDA of the NBRM.

E. Net Domestic Credit to the General Government

24. Net domestic credit to the general government is defined as credit in denar and foreign currency to general government from the NBRM and deposit money banks minus total general government deposits in denar and foreign currency with the NBRM and deposit money banks. For the purpose of this program, accounts of the general government include all accounts recorded as government accounts in the monetary statistics reported by the NBRM in accordance with the definition of general government in ¶1 excluding the unclaimed portion of the payment of principal and interest on frozen foreign currency deposits. The unclaimed amount reached denar 1,432 million by end-June 2003 and is programmed to be reported under other items net in the monetary survey, staring end-September 2003. To ensure the proper reporting of this amount, a separate account will be opened at the NBRM by end-September 2003. Transactions in transitory foreign exchange accounts related to payment operations (account code numbers 7191 and 7192) and foreign exchange accounts related to usage of world bank loan (so called PSDL with accounts code number 2921) are not considered part of government financing.

25. At end-December 2002, the amount of outstanding credit from the NBRM to the general government in denar and foreign currency stood at denar 6,928 million; the amount of outstanding credit from deposit money banks in denar and foreign currency stood at denar 7,895 million; the amount of general government deposits held at the NBRM was equal to denar 17,534 million (including denar 1,142 million corresponding to the unclaimed portion of the payment of principal and interest on frozen foreign currency deposits); and the amount of general government deposits held at deposit money banks was equal to denar 2,461 million.

26. At end-December 2002, net domestic credit to the general government so defined stood at denar -5,172 million (including denar -1,142 million corresponding to the unclaimed portion of the payment of principal and interest on frozen foreign currency deposits). Of this net credit from deposit money banks was equal to denar 5,434 million; and net credit from the NBRM stood at denar -10,606 million.

27. Quarterly ceilings have been established for the cumulative changes in net domestic credit to the general government from the level at end-December 2002 (Table 1 of the SMEFP).

Adjustors

28. The ceilings on net domestic credit to the general government will be subject to the same adjustors as the ceilings on the NDA of the NBRM.

F. Central and General Government Fiscal Balances

29. Quarterly floors for the cumulative changes in central and general government fiscal balances will be determined and monitored from the financing side beginning end-December 2002 (Table 1 of the SMEFP). The financing flows will be measured as a sum of domestic financing, foreign financing, and privatization proceeds.

Domestic financing for the central government includes net credit from the domestic banking system (excluding the unclaimed portion of the repayment of frozen foreign currency deposits), net placement of securities outside the domestic banking system and other net credit from the domestic non-banking sector, and net variation in domestic arrears. Foreign financing for the central government (converted using the valuation methodology described in Section J) includes disbursements of external loans and non-budgetary support grants received by the central government (i.e., balance of payments support as defined in ¶7) minus amortization due or pre-paid, and rescheduled debt service payments programmed to be paid out. Transactions in transitory foreign exchange accounts related to payment operations (account code numbers 7191 and 7192) and foreign exchange accounts related to usage of world bank loan (so called PSDL with accounts code number 2921) are not considered part of foreign financing.

30. Privatization proceeds for the central government include proceeds in denar and foreign currency. It is assumed that in January 2003-March 2004 privatization proceeds for the central government will be equal zero. The central government balance in January-December 2002 was denar -13,019 million.

31. The general government fiscal balance includes, in addition to the central government fiscal balance, the financing position of the institutions included in the definition of general government in ¶1. Monitoring will also be done from the financing side and include, in particular, foreign financing resources linked to the road construction program. The general government balance in January-December 2002 was denar -13,554 million.

Adjustors

The floors on general government fiscal balance will be adjusted upward by any shortfalls of gross external financing to the Road Fund with respect to the following baseline:

The floor on the general fiscal balance will be adjusted upwards on a cumulative basis, by any shortfalls in reducing the stock of VAT refund arrears/ VAT refund claims with respect to the following baseline:

The stock of VAT refund arrears/VAT refund claims stood at denar 1,018 million by end-December 2002 and denar 966 million by end-June 2003.

G. Ceilings on the Wage Bill of the Central Government

32. Quarterly indicative ceilings have been established for the cumulative wage bill from the central government budget from the level at end-December 2002 (see Table 1 of the MEFP). The wage bill ceiling includes all components of chapter 40 of the Macedonian budget classification (this component includes wages and salaries; social contributions; travel, food and vacation allowances; and other related categories in existence in the budget law of the year 2002), and any other personnel related expenses including overtime payments, bonuses, and vacation allowances. No wage bill or personnel related expenditures should be assigned to other budget categories. The wages and personnel expenses paid out of the central government budget chapter 40 during the period January-December 2002 were denar 18,339 million. A separate ceiling is also established on wages and other personnel expenses being paid out of special revenue and expenditures accounts, or the so-called 631, 785, 786, 787, and 788 accounts. Wages and personnel expenses paid out of these accounts in January-December 2002 amounted to denar 640 million.

H. External Debt

33. The limit on medium and long-term debt (Table 1 of the SMEFP) applies to the contracting or guaranteeing by any branch of general government or the NBRM of new nonconcessional external debt with an original maturity of more than one year, with sublimits on external debt with an original maturity of more than one year and up to and including five years. 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 on August 24, 2000 by the Executive Board of the IMF (EBS/00/128, 6/30/00)¹ , but also to commitments contracted or guaranteed for which value has not been received. Excluded from this performance criterion are changes in indebtedness resulting from refinancing credits and rescheduling operations (including the deferral of interest on commercial debt), credits extended by the IMF and the BIS, and credits on concessional terms, defined as those with a grant element of 35 percent or more calculated using the OECD Commercial Interest Reference Rates (CIRRs) applicable for the program period. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time the contract or guarantee becomes effective.

I. External and Domestic Payments Arrears

35. External payments arrears consist of the total past-due amounts of debt service obligations (interest and principal) on government, government-guaranteed, and the NBRM external debt, excluding arrears on external debt service obligations pending the conclusion of debt rescheduling agreements. Under the program, the nonaccumulation of external payments arrears is a continuous performance criterion. As of June 31, 2003 there were no outstanding external payment arrears as defined above.

36. Central government domestic arrears, excluding those to suppliers, are defined to include all payment delays to: (i) banks for bond payments (including for the repayment of frozen foreign currency deposits); (ii) individuals for Social Assistance Program payments; (iii) central government employees including for wages and salaries, and food and travel allowances; (iv) the Employment Fund and the Pension Fund; and (v) benefit recipients of the Child Care Program. The definition excludes the customary lag in paying wages, social assistance and child allowance payments, and transfers to the extra-budgetary funds (in the following month after they accrue). According to the definition here, and as reported to IMF staff, central government domestic arrears, excluding those to suppliers, were denar 0 million as of end-December 2002. Under the program, the outstanding stock of domestic arrears, as defined above, will not exceed at any time the amount outstanding as of end-December 2002, except in cases where payments depend on the adoption of programs to be prepared by budget users and adopted by the government, as stipulated in the 2003 Budget Execution Law.

37. Central government domestic arrears to suppliers are defined as obligations by government entities and institutions, including but not restricted to the Agency for Under?Developed Regions, the Service for Common Government Functions, and the Ministries of Agriculture, Culture, Education, Finance, Defense, Health, and Interior to suppliers which are due but not paid by more than 60 days and are non-disputed. As defined here, and as reported to Fund staff, the stock of arrears to suppliers stood at denar 597 million as of end-December 2002. Under the program, the outstanding stock of domestic arrears, as defined above, will not exceed the amount outstanding as of end-December 2002.

38. Health fund arrears are defined as unpaid obligations to suppliers and health-related personnel. As defined here, and as reported to Fund staff, the aggregate stock of these arrears stood at denar 1,711 million as of end-December 2002. Under the program the outstanding stock of arrears will not exceed the amount outstanding as of end-2002.

J. Valuation

Valuation of the NBRM balance sheet and the monetary survey

39. For the programmed foreign exchange projections, the program exchange rates were applied.

40. Performance of monetary aggregates under the program has been monitored in stock flow methodology for January to June 2003. The stock-flow methodology has the following features: The stocks of assets and liabilities denominated in foreign currency outstanding at September 30, 1996, are valued at the current exchange rate on that day. On a monthly basis, any subsequent changes in assets and liabilities in foreign currencies to residents and non-residents have been valued at the average exchange rates prevailing in the month of the transaction. In particular, changes in the NIR of the NBRM (in denar) have been calculated by applying the average monthly denar per U.S. dollar exchange rate to the monthly dollar value of transactions (equal to the change in NIR excluding valuation effects as calculated by the Foreign Reserves Department of the NBRM). Changes in the telecom privatization account held at the NBRM (in denar) have been calculated by applying the average monthly denar per Euro exchange rate to the monthly Euro value of transactions. Gold is valued at the price fixed in the London market and was valued at end-December 2002 at US$342.75 per ounce.

41. For the remainder of the program, performance will be measured in constant exchange rates. For this methodology, assets and liabilities of the banking system will be valued as follows: The stocks of assets and liabilities denominated in foreign currencies outstanding at December 31, 2002 are valued at the program exchange rate (denar 58.8909 per U.S. dollar, denar 61.3761 per Euro, and cross exchange rates at the level prevailing at end-December 2002). Gold is valued at the price fixed in the London market at end-December 2002 (US$342.75 per ounce). Changes in assets and liabilities will also be valued at these exchange rates. The exchange rate effects on the foreign currency denominated assets and liabilities of commercial banks will be estimated on the basis of their currency composition, as provided by the NBRM banking supervision department.

Valuation of NIR

42. For the programmed foreign exchange projections, the program exchange rates were applied.

43. For program monitoring, the Foreign Reserves Department of the NBRM estimates the valuation effects on the NIR of the NBRM as follows. On a daily basis all foreign currency denominated balances are converted into U.S. dollars using the middle rates from the NBRM official exchange rate list for the same day. These balances are compared to the balances in U.S. dollars at the end of the previous day calculated in the same way (i.e., using the middle rates from the NBRM official exchange rate list for that day). The change in the daily U.S. dollar denominated balances, so calculated, is compared to the recorded daily transaction flows converted in U.S. dollars using the same methodology. Any difference between the two values is attributed to valuation effects.

Valuation of the fiscal deficit

44. For the programmed foreign exchange projections, the program exchange rates were applied.

45. For fiscal deficit measuring purposes, the constant exchange rate methodology was used to convert the foreign currency component from January to June 2003. For measuring the fiscal deficit for the remainder of the program, the foreign currency component of deficit financing will also be converted at constant exchange rates.

K. Monitoring and Reporting Requirements

46. Performance under the program will be monitored from information provided to the IMF by the NBRM and the Ministry of Finance. All data will be monthly, unless otherwise specified, and should be submitted by the authorities to the IMF staff within 30 days of the end of each month, unless otherwise specified. In addition, data on performance at the program test dates will be submitted with a cover letter signed by an authorized official.

47. The following information will be supplied to the IMF by the Ministry of Finance: (i) fiscal table for the central government and extra-budgetary funds; (ii) monthly information on privatization receipts (including detailed description of cash payments in local and foreign currency and payments with government bonds); (iii) data on enterprises including action taken and workers registered as unemployed; (iv) information on special revenue accounts of line ministries and separately on personnel expenditures financed from these accounts; (v) information on guarantees given on new debt, and on new debt contracted by the government, government agencies, and public enterprises; (vi) information on domestic arrears, including to suppliers and distinguishing between court disputed and non-disputed arrears; (vii) data on spending on projects and repayment to pensioners (agreed under the program as uses of privatization receipts from the sale of the Telecom company), and outlays on structural reforms; (viii) data on the claimed and unclaimed portion of the repayment of frozen foreign currency deposits; and (ix) information on number of workers registered under the employment subsidy scheme.

48. The NBRM will supply: (i) balance sheets of the NBRM and the consolidated accounts of the commercial banks — both should include details of the credit and deposits position of funds and other government entities as listed in ¶1; (ii) the monetary survey; (iii) data on components of NIR of the NBRM as defined in section A, valued in U.S. dollars adjusted for valuation changes; (iv) statement from the Road Fund indicating its balances (in denar and foreign currency) at the NBRM and at the commercial banks separately; (v) the foreign exchange cashflow of the NBRM, including the level of official reserves; (vi) record of transactions in the privatization account identified by their use and valued in U.S. dollars and Euros; (vii) daily and monthly closing and average exchange rates; (viii) detailed data on exports and imports; (ix) information on all overdue payments on short-term external debt and on medium- and long-term external debt; (x) data on foreign borrowing including gross disbursements, amortization, and interest payments; (xi) information on lending by domestic money banks according to credit ratings of borrowers; (xii) data on off-balance sheet activity of domestic money banks; and (xiii) data on each domestic money banks' compliance with prudential regulations will be provided in a quarterly basis till end-2001 and in a monthly basis thereafter within 30 days of the end of the quarter/month; (xiv) Detailed reporting on commercial banks assets and liabilities, including breakdowns by currency, currency indexation, maturity and sector, starting March 2004 on a quarterly basis; (xv) Quarterly information on commercial banks lending indexed to foreign currencies. Monthly data on all components of balance of payments will be submitted within 2½ months of the end of each month. Data on stock of external debt will be provided on a quarterly basis, within 30 days of the end of the quarter.

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¹ Under the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 by the Executive Board of the IMF the definition of "debt" has been broadened with respect to the conventional definition to include, among other things, such instruments as financial leases.