Dear Mr. Köhler,

1. Tanzania continues to implement its programme for poverty reduction with the support of the IMF through a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) extending to June 2003. The fifth review under the arrangement was concluded by the Executive Board of the IMF in November 2002. This letter requests completion of the sixth and final review under the current PRGF arrangement. In addition, the Government requests for a low access PRGF arrangement with the IMF. To this end, this letter discusses progress in implementing the programme since mid-2002 and sets out the Government's policy intentions for the medium term and targets for the fiscal year 2003/04 (July-June). The first disbursement under the requested PRGF arrangement is subject to a review expected to be completed by December 2003.

I. RECENT ECONOMIC PERFORMANCE AND POLICY IMPLEMENTATION

A. Macroeconomic Developments

A. 2. Tanzania's macroeconomic performance continued to improve in 2002, accompanied by a strong economic expansion. The GDP growth rate rose from 5.7 percent in 2001 to 6.2 percent in 2002, despite the continued worsening in the terms of trade and a slowdown in tourism related to the current adverse global security situation affecting travel. Growth in 2002 stemmed from relatively strong performances in agriculture, mining, manufacturing, as well as wholesale and retail trade. The 12-month rate of inflation declined further, from 4.5 percent in June 2002 to 4.3 percent in April 2003. Gross official reserves of the Bank of Tanzania (BoT) stayed well above six months of imports of goods and services.

B. Performance Under the Program

3. The quantitative benchmarks and performance criteria on central government revenue and the net domestic financing of the central government were met by wide margins. All other quantitative performance criteria and benchmarks for end-December 2002 were also observed (Table 1). The following structural performance criteria and benchmarks were observed (Table 2): i) Introducing a treasury voucher system for administering the tax exemptions applying to non-religious NGOs and to imports of motor vehicles by eligible public servants; ii) Issuance of guidelines to local councils for the harmonization of taxes, levies and licenses; iii) Requiring spending agencies to submit to the Accountant General quarterly reports on their utility bills and amounts paid, starting with a report for the first quarter of 2002/03; iv) The identification of budgetary codes for priority expenditures and applying them in the budget guidelines for 2003/04; v) Establishing the National Debt Management Committee under the National Debt Strategy; and vi) Submission to parliament of the draft law establishing the legal, regulatory, and supervisory framework for microfinance operations. The structural performance criterion on submission to Parliament of amendments to the Loans, Guarantees and Grants Act by February 2003 was delayed, and we request a waiver for the non-observance of this performance criterion. However, the bill has subsequently been passed by Parliament in April 2003. The implementation of the centralized motor vehicle registration system was also delayed owing to litigation by a vendor; however, the system started functioning in May 2003.

C. Fiscal Developments

4. Government revenue has remained consistently above estimates during the first three quarters of the fiscal year 2002/03, and has grown by 18 percent over the same period last year. The most notable features are the strong revenue performance of VAT on domestic goods and income tax, while a negative growth was registered over the last year in taxes on petroleum imports. This strong revenue growth is due to a combination of policy changes; administration improvements; and expansion of the economy.

5. Total expenditure for the three quarters ending March 2003 was Tsh. 1226 billion, or 77 percent of estimates. This underperformance is due to delays in programme loan disbursements which reduced the resource envelope; slow execution of discretionary expenditure; and delays in procurement. Notwithstanding the shortfall in foreign financing, priority sectors have continued to receive their full quarterly allocations in line with their respective cash flow requirements. In addition, full budgetary allocations were provided for the Population Census and HIV/AIDS priority interventions via TACAIDS. The net domestic financing (NDF) position of the Government at the end of March 2003 registered a net borrowing of Tsh 28.4 billion.

D. Progress in Public Financial Management Reform

6. The Government has continued with efforts to establish effective and sustainable financial management arrangements to support the equitable delivery of public services, to minimize resource leakages, and to strengthen accountability. In this regard, the Government has revised the Public Financial Management Reform Programme (PFMRP) taking forward relevant Country Financial Accountability Assessment (CFAA) and Report on Observance of Standards and Codes (ROSC) recommendations as well as recent developments, including the new Public Finance and Public Procurement Acts. The Government is continuing to work on the remaining seven benchmarks emanating from the priority expenditure tracking study that was conducted as part of the PRSP/HIPC process and we are confident that they will all be met in the ensuing two years. The Integrated Financial Management System (IFMS) has continued to be the main source of report generation for the Government's budgetary operations. In order to increase transparency, reports relating to budget execution and public debts in addition to being published in the local media are also posted on the national website. The Government will continue holding Public Expenditure Reviews in order to take on board views and opinions of the general public and other stakeholders.

7. Utility commitments in the IFMS have continued to be effected on behalf of Ministries, Departments and Government Agencies (MDAs). On a quarterly basis, utility reports showing amounts paid against amounts billed and committed are produced. This allows for tracking and monitoring the payment of utility bills received by MDA's to utility entities. So far, reports indicate that MDAs are paying their bills consistent with bills they receive.

E. Implementation of the Poverty Reduction Strategy

8. Tanzania continues to implement its Poverty Reduction Strategy (PRS). The second annual PRS progress report which outlines the implementation of the PRS, was finalized and published in March 2003. It was prepared on the basis of participatory discussions including a wide range of stakeholders during both the Poverty Policy Week in September 2002 and the Consultative Group meeting held in Dar es Salaam in December 2002. It has also incorporated comments from the World Bank and IMF staff.

9. The annual PRS progress report 2002 draws on the Poverty and Human Development Report (PHDR). This presents information on the implementation of various aspects of the PRS and was also discussed during the Poverty Policy Week in September 2002. It included major findings from the Household Budget Survey (HBS) and the Integrated Labour Force Survey (ILFS), both of which have been published as separate reports. The Participatory Poverty Assessment (PPA) programme was launched in 2002 as part of the poverty monitoring framework. The field work was conducted during April-June 2002 and the report is currently being finalized. The PPA has focused on vulnerability, an area which was identified to have an information gap in the original PRSP. In an effort to advance the Poverty Monitoring System (PMS), a set of existing poverty monitoring indicators of social well-being identified in the Poverty Monitoring Master Plan are being developed further based on data availability, data quality and relevance to poverty.

F. Monetary and Financial Sector Developments

10. During the first three quarters of 2002/03, developments in monetary aggregates remained encouraging. The actual outturn on net domestic assets, and net international reserves met the requirements of the PRGF performance criteria. The stock of reserve money at end March 2003 was below the PRGF target for the quarter ending March 2003 of Tsh. 666.4 billion by Tsh. 16.8 billion, reflecting concerted efforts by the Bank of Tanzania to contain liquidity during the period. However, broad money supply, M2 grew by 18.5 percent and was above the programme target of 17.9 percent, while M3 grew by 19.6 percent against the programme target of 16.0 percent. The increases in M2 and M3 were due to changes in the money multiplier, caused by higher than projected growth in deposits, largely attributed to opening of new bank branches by commercial banks in areas that previously did not have banking services. Other reasons for the rapid growth in deposits include the realization of privatization proceeds of about TZS 20 billion, introduction of automatic teller machines (ATMs) by commercial banks, plus the issuance of new bank notes by the Bank of Tanzania. The depreciation of the shilling revalued upwards foreign currency deposits in terms of Tanzania shillings on the balance sheets of banks and in the monetary survey.

11. Given the unanticipated nature and unusual sources of liquidity creation since the beginning of 2002/03 fiscal year, the ordinary instruments available to the Bank of Tanzania were not adequate to mop up the excess liquidity. As liquidity build up continued, alternative means of bringing down the rate of monetary expansion had to be sought. As a first step, the government agreed with the Bank of Tanzania to securitize Tsh 40 billion of a hitherto dormant government stock held by the Bank of Tanzania. This has already been converted into long-term treasury bonds. Furthermore, Tsh 80 billion was also securitized in the form of 35, 182 and 364-day treasury bills, and is currently being replaced by long term bonds. The process has however, taken longer than projected following unanticipated low demand in the Treasury bond market, brought about by investment diversification by major institutional investors, particularly the pension funds which have recently increased their investments in real estate business.

12. During the review period, commercial banks' weighted average lending and deposits rates exhibited a downward trend and the margin between average deposit and lending rates narrowed from 12.6 percentage points in June 2002 to 11.7 percentage points in March 2003. The overall lending rates declined from 16.4 percent in June 2002 to 15.0 percent in March 2003, while the average deposit rate fell from 3.8 percent to 3.3 percent. The downward trend of deposits rates reflected developments in the T-bills market. The average savings deposit rate fell from 3.5 percent to 2.8 percent and the average time deposit rate decreased from 4.0 percent to 3.7 percent in the same period. Considering the inflation rate of 4.2 percent for March 2003, deposit rates were negative in real terms, except for the 6-month, 12-month and 24-month time deposits, which were positive in real terms at 4.2 percent, 5.8 percent and 4.4 percent, respectively. The prevailing wide spread between deposit and lending rates coupled with negative real interest rates on some deposits stems from structural as well as institutional impediments that still remain in the economy. Many of these impediments will be addressed in the course of 2003/04.

G. Public Debt Management

13. Public debt developments were broadly on track. Domestic debt market developments continued to be favourable. This was encouraged by the successful floatation at the stock exchange of the 5-year Treasury bond in February 2002, the launching of a 7-year fixed rate Treasury bond in August 2002 and 10-year bond in October 2002. These new bonds are part of the ongoing efforts to convert unsecuritized debt into marketable securities.

14. As regards external debt, there has been some progress in concluding bilateral agreements under Paris Club VII. To date, agreements have been signed with Austria, the United States, Canada, Belgium, France, Netherlands, Norway, Germany and Italy. The United Kingdom has notified the Government of Tanzania that it is providing total debt cancellation and that there is therefore no need for a bilateral agreement. Recognizing the genuine difficulties faced by the Government in expediting the process, the creditors, through the Paris Club Secretariat, have agreed to extend the deadline for bilateral agreements to June 30, 2003.

15. The Government has been consistently appealing to the Non-Paris Club official and commercial creditors to extend debt relief on terms comparable to those under the enhanced HIPC framework, but there has been little progress. So far, only Kuwait has provided debt relief under the HIPC framework. China and India have offered debt relief by canceling some of the debts but not on terms comparable to the PC. In addition, some dialogue has been initiated with Libya, but no commitment has been made yet. Also, discussions are going on with the Government of Russia with regard to claims of moratorium interest under PCVI bilateral agreements. We have written to the Paris Club Secretariat to ask for clarification of the issues involved. To underscore its strong commitment to reaching agreement with these creditors, the Government has recently established a foreign currency escrow account managed by the Bank of Tanzania into which it has deposited US dollar 5 million, equivalent to 12.5 percent of the estimated debt service due to these creditors after application of the enhanced HIPC debt relief terms. In this regard, the government would appreciate the assistance of the Fund and the Bank in encouraging participation of the non-Paris Club creditors in the debt relief initiative.

H. External Sector

16. During 2001/02, the external current account deficit improved to 8.9 percent of GDP (excluding current official transfers) from 9.4 percent of GDP a year earlier. Non-traditional exports, gold in particular, performed well during most of 2001/02. However, traditional exports recorded their worst performance in recent years mainly due to falling export prices in the world market for coffee, cotton and cashew nuts. Imports increased by 8.0 percent largely on account of an increase in the imports of capital and intermediate goods. However, there was significant decrease in imports of consumer goods, in particular, foodstuffs owing to favourable weather conditions. There has also been a decline in official grants during the year under review compared to 2000/01 levels. Gross external official reserves rose to USD 1546.1 million at the end of March 2003, equivalent to 7.5 months of 2002/03 imports of goods and non-factor services.

II. POLICY DIRECTION FOR THE MEDIUM TERM

17. Over the medium term, we anticipate growth to accelerate to 6-7 percent, while containing inflation at an average of 4 percent. Given Tanzania's population growth, such real growth rate would support an annual increase in per capita income of about 3 percent. We project the current account deficit to decline slightly, as substantially higher exports of goods and services are mostly offset by higher imports reflecting increased consumption and private investment.

18. Our growth projections are underpinned by an increase in both private and public investment over the average of 2000-02, as public investments favorably impact the business environment and support higher private investment. To accomplish this rise in investment, we will implement a range of measures to remove impediments to investment. Our efforts in this direction will be assisted by the dialogue with investors in the context of the Investors' Roundtable. We will also seek to continue with trade liberalization to enhance competitiveness.

19. Given the preponderance of agriculture in Tanzania's economy and the fact that little progress has been made in reducing poverty in the rural areas, improvements in the agricultural sector will be critical in strengthening our growth performance and achieving the objectives for poverty reduction under our PRSP. With our development partners, we are implementing the Agricultural Sector Development Program and the Rural Development Program which centers on the support of policy efforts at the district and field levels by strengthening access to financing and marketing. Engines of growth will furthermore be the services and industrial sectors, notably tourism and manufacturing, which are expected to grow more strongly in response to our efforts at improving the business climate. Furthermore, we expect utility services to improve once DAWASA and TANESCO are privatized, as anticipated, while growth in the mining sector will remain buoyant.

20. We recognize that the effective use of higher aid flows in support of these objectives may be constrained by limited absorption capacity and the potential upward pressure on the exchange rate from additional aid flows. To address these risks, we will redouble our efforts at improving absorption capacity by strengthening institutional capacity, particularly in the public service, removing bottlenecks in the infrastructure, and improving governance.

III. POLICIES FOR FISCAL YEAR 2003/04

A. Poverty Reduction Strategy

21. Tanzania remains committed to the Development Vision 2025 goal of reducing poverty. The National Poverty Eradication Strategy (NPES) 1997, the Poverty Reduction Strategy Paper (PRSP) 2000 as well as the first two annual progress reports, and the Zanzibar Poverty Reduction Plan 2002 form the framework within which to achieve this goal. In the coming fiscal year, the Government will strive to achieve the targets set in the annual PRS progress reports which center around the maintenance of macroeconomic stability, structural reforms, the promotion of pro-poor growth and the creation of employment. The third annual progress report will contain valuable information drawn from the Population and Housing Census (September 2002), and from an Agriculture Survey to be conducted in 2003. The former will measure poverty indicators more directly and at a highly disaggregated level, providing key information that will make the PRS more responsive to specific local problems. The latter will provide better understandings of the linkages between agriculture, the main economic activity, and poverty, and will thereby help to better inform the implementation of the PRS, the Rural Development Strategy and the Agriculture Sector Development Strategy. Beginning with the fiscal year 2003/04 poverty reducing expenditure will be specified with GFS codes for effective monitoring of performance. They will apply for central government expenditures as well as for local government subventions in PRS sectors.

22. To promote more efficient implementation of the PRS, the Government intends to approve, by March 2004, an updated action plan for strengthening and sustaining capacity of the Secretariat in the Vice President's Office (VPO), as well as in the President's Office - Regional Administration and Local Government (PO-RALG) coordination and monitoring unit, in order to improve the ability to collect, collate and analyse administrative data. Furthermore, under the PRS Action plan, the Millenium Development Goals will be integrated into the Poverty Monitoring framework by November 2003.

B. Macroeconomic framework

23. The overarching focus of policies in 2003/04 will be towards consolidating and maintaining macroeconomic stability and strengthening domestic resource mobilization and the external sector, whilst implementing key sectoral strategies, as outlined in the PRS. In the absence of exogenous shocks, the real GDP was earlier projected to grow by 6.3 percent in 2003, rising to 7.4 percent by the year 2006. However, there has been a drought in some parts of the country in the early part of 2003, which could significantly affect agricultural output and thus lower growth prospects. Moreover, global security concerns will likely have an adverse effect on tourism. Thus for purposes of the program, GDP growth for 2003 is cautiously estimated at 5.5 percent. Monetary policy will be geared towards reducing the inflation rate to about 4 percent by end-June 2004, after rising to 6 percent at end-2003 because of the impact of drought on food prices. Thereafter, the inflation rate is projected to decline to below 4 percent, consistent with the average inflation rate in our major trading partners. The exchange rate is freely floating, with the Bank of Tanzania intervening only to smoothen wide fluctuations and for the purpose of liquidity management.

C. Fiscal Policy and Budgetary Reform

24. The current revenue to GDP ratio is inadequate for meeting the current salaries and other current expenditures of the Government. This is a source of great concern, as the low revenue yield makes the budget dependent on donor inflows. This situation calls for a sustained revenue mobilization effort in order to improve revenue collections and hence enhance the government's ability to finance budgetary operations. In this context, the focus of 2003/04 fiscal policy is to raise the revenue yield, measured by the ratio of revenue to GDP, to above 13 percent. Efforts will be directed towards reviewing the taxation system so as to rationalize tax policy and simplify tax administration, curbing tax evasion, and reducing tax exemptions. The government aims to implement key recommendations from the IMF report on priorities and strategies for revenue administration reforms, the Public Expenditure Review study on tax policy and administration and the government commissioned study on estimation of potential revenue gaps for Tanzania in order to raise the revenue yield. In the tax area, in particular, the Government's objectives will include significantly increasing the effectiveness of TRA operations by (i) adopting self-assessment of income tax liabilities; (ii) integrating existing tax-based departments in a functional organization structure; (iii) strengthening compliance management of large taxpayers through implementation of the above reforms in the Large Taxpayer Department by January 1, 2004 (structural benchmark); and (iv) simplifying VAT administration. Specific measures include:

i. In the sphere of income taxation, the Government intends to submit to Parliament by end-October a new income tax act which is to become effective on January 1, 2004. The Act is based on the principle of self-assessment, brings the legislation in line with the current economic and business environment, and removes all discretionary powers to grant tax exemptions. We will also propose to parliament the abolition of the stamp duties on receipts, with the new income tax law. The new income tax law will include a new presumptive tax with adjusted rates to offset the loss of revenue from abolishment of the stamp duty on receipts. These measures will simplify tax administration and improve tax collection by removing complexities of the current income tax act;

ii. In order to rationalize the exemptions regime, the Government intends to carry out a number of measures. Firstly, the Government is mindful that prior to 1997 certain government notices relating to tax exemptions were issued that were either too generous or difficult to administer. In order to rectify this situation, the government will during the fiscal year 2003/04 revoke all government notices relating to tax exemptions issued prior to 1997. These government notices will be replaced by new ones that would either place a quantitative restriction on exempted goods or place a time bar on the tax exemption. This move will tighten the current exemptions regime. Secondly, in the context of its ongoing comprehensive review of tax laws which is expected to be completed during the fiscal year, the government will submit to Parliament amendments to the Customs Tariff Act, Excise Ordinance, and Stamp Duty Tax Act removing all discretionary power to grant exemptions from import, excise, and stamp duties and vest the authority with parliament. Thirdly, to improve control of exemptions in the medium term, in 2003/04 the voucher system will be extended to administer tax exemptions to religious NGO's;

iii. The Tanzania Revenue Authority (TRA) has prepared the second corporate plan for the 2003/04 - 2007/08 period with a view to modernizing its organization and operations, and improving its effectiveness. In particular, the government will endorse the corporate plan by end-June 2003 and will mandate its implementation. Also, the TRA will re-engineer its business processes and develop an integrated computer system. These measures will be implemented in the Large Taxpayer department before implementing them across the organization. In addition, steps will be taken to increase the number of taxpayers registered with the Large Taxpayers Unit;

iv. To simplify our tax system and to improve administrative efficiency, we will revise the VAT threshold by June 2004 with a view to reducing the number of taxpayers covered and revise presumptive tax rates to compensate for the revenue loss.

v. In view of the recent unsatisfactory performance of petroleum taxes, the Government is taking measures effective July 2003, that would make the petroleum sector less susceptible to evasion and improve compliance.

vi. The setting up of Export Processing Zones (EPZ) is intended mainly to boost employment as well as diversify exports, in particular in view of the opportunities presented by AGOA exports to the US and EBA exports to the EU. The Government is also mindful of the importance of avoiding revenue leakages. Therefore, we will license only companies which can verify that they already have access to the AGOA and EBA exports, and will produce exclusively for these markets. Moreover, we will amend the regulations to strengthen the rules and procedures to avoid tax leakages. We will also undertake, with Fund technical assistance, a comparative study of the benefits from tax incentives from EPZs in the region. In addition, no new companies will be added to the list of Strategic Investors maintained by the Tanzania Investment Center.

vii. The government has decided to operationalise in 2003/04 the Joint Finance Commission between the Union Government of Tanzania and the Revolutionary Government of Zanzibar. This Commission will aim at strengthening budgetary coordination.

25. According to the budget projection for 2003/04, total expenditure has been provisionally forecast at 22.5 percent of GDP in 2003/04 representing an increase of 2.0 percentage points from the previous year. The government intends to pursue the civil service pay reform and in this context the civil service wage bill has been forecast to increase by an average of 13 percent in 2003/04. The increase is planned to cover new recruitment, refinement of pay structures as well as pay rises. In addition, the number of staff at lower grades will be reduced.

26. Priority expenditures in 2003/04 will be enhanced in line with the PRS and all priority sectors and items will continue to be protected while critical allocations for services like utilities will continue to be ring-fenced. The specific requirements to attain the poverty outcome targets of the Poverty Monitoring System, particularly in the social sectors of health and education will be met. In order to increase transparency and improve tracking of priority expenditures, the budget for 2003/04 will specifically include a table showing poverty-reducing items. Efforts are also ongoing to introduce functional classification and the adoption of GFS uniform codes. Starting 2003/04, the quarterly Budget Execution Reports will incorporate reports on poverty-reducing expenditures based on IFMS.

27. Total foreign project expenditures is forecast at 4.2 percent of GDP, above the budget level in 2002/03. Budget support grants are expected to increase from 3.2 percent of GDP in 2002/03 to 3.4 percent in 2003/04. Taking account of the revenue and expenditure estimates above, bank financing of the government during 2003/04 will be limited to TSh 42.7 billion.

28. The large number of local government taxes and licenses has been identified as a significant impediment to investment. A strategy for harmonisation of local government taxes and levies was developed in April 2002 and the relevant guidelines were issued to local authorities in December 2002. The government intends to continue to implement these guidelines during 2003/04 so as to address the concerns of stakeholders voiced during discussions between the private sector and the government. To this end, the Government has identified taxes to be abolished, particularly those which are considered to be nuisance and those which undermine the Government's efforts to fight poverty.

29. The Government has continued applying Financial Management of Public Funds consistent with the requirements of the Public Finance and Public Procurement Act (2001). However, the regulations in these acts are being reviewed in order to reduce unnecessary bottlenecks and allow for an unencumbered procurement process, while maintaining internal controls. In 2003/04, the government intends to procure an aircraft and will ensure that procurement procedures are followed in accordance with the Public Procurement Regulations. Any associated financing would be on concessional terms, consistent with the program. Off-budget payments for the purchase of the air traffic control system have been regularized by presenting a supplementary warrant to the Parliament. Furthermore, key reforms will be made in the context of the implementation of the revised Public Financial Management Reform Programme, which will be continued in the coming fiscal year. These reforms will include the consolidation of improvements within IFMS so as to ensure that no budgetary arrears accumulate.

D. Monetary Policy and Financial Sector Reform

30. The Bank of Tanzania will continue to monitor closely domestic as well as international economic developments in order to take appropriate monetary policy measures to ensure continued macroeconomic and financial stability and the maintenance of external competitiveness. The monetary program for 2003/04 targets reserve money of Tsh 764 billion at end - September 2003, Tsh 826.1 billion at end-December 2003 and Tsh 808 billion at end March 2004. The targets for net domestic assets and net international reserves of the Bank of Tanzania for end-September 2003 and end March 2004 are Tsh -584 billion and USD 1,287 million, and TZS -579 billion and USD 1,324 million, respectively. Reserve money and NIR for end - September 2003 and end - March 2004 will be monitored as performance criteria under the program, while NDA will be a benchmark. Broad money (M3) is projected to increase to Tsh 2475.3 billion at end-December 2003 and to TZS 2539.9 billion at end June 2004, or by 20.9 percent et end - December 2003 and 17.2 percent at end-June 2004, respectively. Liquidity management will be targeted towards ensuring that growth in monetary aggregates is consistent with the program targets. In particular, monetary policy will be geared to ensure that the expected increase in inflation related to the food shortage would be temporary and to be largely reversed before the end of the fiscal year 2003/04. The main focus of monetary policy will be to control the increase in excess liquidity expected to emanate mainly from the projected large increase in foreign inflows. In this regard, the Bank in collaboration with the Government will increase the supply of long-term instruments in the market in order to augment substantially the supply of instruments to mop up excess liquidity. In view of the recent increase in the demand for money, we have operationalized the daily liquidity forecasting framework to strengthen reserve money management. To this end, the Bank of Tanzania will conduct timely and targeted sterilization operations with treasury bills (liquidity paper) and other instruments. Open market operations will remain the main monetary policy instrument, supplemented by foreign exchange market interventions.

31. To remove the remaining impediments in the development of the financial sector, amendments to the Land Act, which continues to hamper the use of land as collateral will be presented to Parliament in October 2003 (structural performance criterion). In the meantime, the proposed draft amendments will be reviewed jointly by the Ministry of Lands, the Attorney General Chambers, the Bank of Tanzania and the Tanzania Bankers Association to ensure that they are consistent with the Government's objective of increasing access to bank credit by a much wider range of borrowers in the population in order to promote a high rate of growth of the economy needed to accelerate poverty reduction. Other policy measures in this area will aim at improving the land registry, and enhancing the capacity of the judiciary, including the commercial court, through the employment and training of more judges, with a view to keeping the average case resolution for the commercial court to below six months. The Government is also considering other avenues for promoting property rights. The Bank of Tanzania will endeavour to ensure that the credit information bureau is established in line with the framework that the Bank of Tanzania has already prepared. The Ministry of Lands will be provided with the necessary financial and technical support to computerize and improve the land registry. Given the sharp drop in traditional exports, the Export Credit Guarantee Scheme will continue to be strengthened in order to sustain rural incomes and increase exports.

32. The Bank of Tanzania intends to strengthen the regulatory and supervisory framework for micro-finance institutions and to generally strengthen the overall supervision of the financial sector in order to enhance the stability of the financial system. Efforts are underway to introduce a more diverse range of products, including putting in place an enabling environment, which will facilitate the provision of long-term finance to the productive sector. The Bank of Tanzania will by December 2003 review relevant prudential regulations and legislation with a view to relaxing some of the credit limits, such as the requirement to raise the collateral equivalent to 125 percent of the loan amount and the aggregate ceiling for large loan exposures as a ratio of the bank's core capital. The Bank of Tanzania will pay due regard to the work of the recent IMF Mission regarding Tanzania's future prospects for accessing foreign private capital and of the report of the FSAP mission.

33. To preserve the soundness of the financial system, in March 2003, the Bank of Tanzania took over the management of the Delphis Bank following the poor financial performance of the bank and the inability of its shareholders to inject additional capital to cover losses incurred in its operations. While under the administration of the Bank of Tanzania, all the bank's operations have been proscribed. Discussions are underway for new shareholders to capitalize the bank and re-open it under new management. At the same time, the Government is implementing a comprehensive restructuring plan to address the long-standing problems of the People's Bank of Zanzibar. To strengthen the capital base of the banking system, the Bank of Tanzania has adopted a phased increase in the minimum paid up capital of commercial banks. The Government is cognizant of the need to strengthen measures against anti-money laundering and financing of terrorism. To this end, Tanzania is implementing the recommendations of the financial task force under the East and Southern African Anti-Money Laundering Group.

E. Debt Sustainability

34. The Government has started implementing the key recommendations of the recently approved National Debt Strategy. The improved procedures will be formalized by gazetting the recently approved amendments of the Government Loans, Guarantees and Grants Act, 1974. In light of a large stock of parastatal debt, the Government has initiated a study with the aim of getting a clearer understanding of the maturity profile of these contingent liabilities, as well as suggesting ways to fund repayment of the same when need arises. The study was commenced in February 2003 and is expected to be completed by the end of December 2003.

F. Other Structural Reforms

35. The parastatal sector reform programme continues to make substantial progress. The divestiture of Air Tanzania Corporation was concluded during December 2002 while DAWASA was concessioned out to private operators in February 2003. The focus over the medium term will remain on privatization of large utilities, including TANESCO, the Tanzania Railways Corporation, and the Tanzania Harbours Authority. Pursuant to the government's policy of privatizing public enterprises the budget for 2003/04 will provide for the possible cost of retrenchments for enterprises subject to privatization in 2003/04, in line with the government's policy to provide only statutory benefits. The Government will also ensure that following privatization, adequate regulatory frameworks will be established so as to protect consumer welfare. In this vein, the regulatory agency for the water and electricity sectors (EWURA) will begin operations in July 2003.

36. There have been delays in the privatization of the National Microfinance Bank (NMB) on account of concerns expressed by unions and parliamentarians. Nevertheless, the government is committed to improve the efficiency of the financial system and to promote the interests of rural areas and smallholders by addressing expeditiously the problems of the bank, including the need for government subsidies. Accordingly, the government will adopt a revised strategy for dealing with the NMB by mid-July, and expects that by the latter half of 2004 the NMB will be privately owned and managed to enable it to contribute to improving microfinance in Tanzania.

37. In the area of private sector development, it is recognised that Small and Medium Enterprises (SME) play a crucial role in employment creation and income generation in Tanzania. The Government is committed to the SME development policy, which was adopted in February 2003 and is expected to be ready for implementation by November 2003. The strategies for implementing the policy in the medium term focus on three main areas, namely the creation of an enabling business environment; the development of financial and non-financial services strategies; and the establishment of a supportive institutional infrastructure. Consultations with the private sector will be promoted and Government aims to ensure representation of SME relevant issues on the agenda of the Tanzania National Business Council.

38. In view of promoting the business environment, a better regulatory unit for the Business Environment Strengthening for Tanzania (BEST) programme will be operationalised through provision of adequate staffing and resources. In addition, by December 2003, we will adopt an action plan to reform and simplify the business licensing system after further consultation with stakeholders and prepare a related position paper. Furthermore, a new labour policy and revised Labour Act has been prepared in consultation with stakeholders and will be submitted to parliament by October 2003.

39. A key reform in the area of rural development will be to prepare and issue a prioritized strategic plan and a corresponding program to strengthen the administrative capacity for implementation of the Land Act and Village Land Act. Other reforms include: the enforcement of the microfinance legislation and regulations; preparation of monitorable benchmarks for assessing the effectiveness of coordination mechanism for the implementation of the Agricultural Sector Development Program; review of the role and funding of crop boards to limit their functions to regulatory activities; and to develop proposals to strengthen the institutional arrangements for district road maintenance and rehabilitation.

40. In an effort to improve public sector performance, during the next fiscal year, the government intends to enhance pay in line with the approved budget for 2003/04. In addition, we will amend the local government service regulations to be in line with the Public Service Act by November 2003.

41. Transparency of budget execution, centrally as well as locally, will continue to be maintained by the publication of quarterly budget execution reports by the Government (on the national website) and the LGAs (which submit their reports to PO-RALG which then consolidates the information). Furthermore, an expenditure tracking survey is due to be completed in the next fiscal year under the Public Expenditure Review.

42. Consistent with the Poverty Reduction Strategy, the Government has continued to make progress in the promotion of good governance, including the implementation of the National Anti-Corruption Strategy and Action Plans (NACSAP) of ministries, independent departments and agencies. In this regard the second quarterly report on the implementation of NACSAP was published in March 2003. In order to address coordination and implementation of the National Anti-Corruption Strategy and Action Plan (NACSAP) 2003-2005, a report assessing the necessary human and financial resources will be finalized by November 2003, which will subsequently guide the provision of these resources to the implementing institution. In addition, the revised code of conduct will be made available for public servants, and a mechanism for complaints and grievances will be subsequently put in place to deal with unethical conduct. For the 2003/04 budget, the anti-corruption action plans for all LGAs will be included, following which the Government will ensure effective implementation of the plans. Beginning this fiscal year, the government will publicize within two months of the end of each quarter the name and exemption amount for companies, NGO's, and individuals that have received exemptions during the quarter (structural performance criterion).

43. Various other reform programmes in the area of good governance are ongoing, progress of which have been presented in 2002 PRS progress report. To provide a solid basis for these reforms the commission of Human Rights and Good Governance has been established and is now fully operational. The establishment of this commission is a milestone in ensuring administrative justice which is greatly expected to contribute towards the promotion of good governance in the country.

G. External Sector Issues

44. The improvements in the external accounts in recent years were a result of large inflows of external assistance and growth in mining exports and tourism receipts. The government's efforts to strengthen the external accounts in the medium term will focus on reversing the sharp decline in traditional exports, increasing agro-industry and manufactured exports, and in attracting foreign direct investment and other nondebt- creating financial flows. The 46.2 percent decline in the earnings from traditional exports over the past three calendar years reflects not only the sharp decline in agricultural commodity prices in world markets, but also stagnant volumes of key exports. The government is facilitating efficient marketing of output, through the recently established export credit guarantee facility, and will encourage the development of high value agricultural exports and manufactured products. In this context, the government understands that there is a supply side constraint which limits the opportunity to play a significant role in the African Growth Opportunities Act (AGOA) of the USA and Everything But Arms (EBA) of the EU. Government recognises that by establishing a supportive institutional infrastructure, small- and medium-size enterprises can contribute substantially by providing competitive products to sell under AGOA. We have also initiated a capacity building process to strengthen the competitiveness of Tanzanian products, especially non-traditional ones. It is also expected that the implementation of EPZs, targeted exclusively to exporting firms, will support the development of manufactured exports.

45. Export competitiveness will be enhanced by a further reduction in import tariffs and removal of non-tariff barriers over the medium term. Institutionally, such trade liberalization must occur mainly within the framework of the East African Community (EAC).In June 2003 member states of the EAC agreed to adopt a common external tariff with three bands (0, 10 and 25 percent). The Customs Union Protocol of the EAC is expected to be signed in November 2003. There are also ongoing efforts to eliminate all non-tariff barriers within the EAC and SADC. The government is committed to phasing out the suspended duties imposed on a short list of imported commodities and will review the time frame in the context of the EAC trade protocol negotiations and enactment of antidumping legislation. To promote inflows of private capital through liberalization of portfolio investment, the government has revised the regulations of the Dar es Salaam Stock Exchange to allow foreign participation. The Bank of Tanzania, in collaboration with the Capital Market and Securities Authority, established modalities to guide foreign investors' dealings and has developed institutional arrangements for monitoring private capital flows, as well as instituting appropriate regulations that will provide the necessary safeguards.

46. The external current account deficit, before grants, estimated at 11.8 percent of GDP in 2003/04 is projected at 10.5 percent in 2004/05 and 9.6 percent in 2005/06. Exports of goods and services are projected to grow by an annual average of 9.3 percent, over the three years, as traditional exports and tourism receipts recover slowly, and mining exports continue their good performance. Imports are projected to grow on average by 10.3 percent over the three years, with a sharp increase in 2003/04 on account of anticipated large food imports related to the prevalent drought, and a rise in investments and capital imports. The external financing requirement of US$ 1.1 billion per year over the three years is expected to be covered by external assistance in the form of grants, concessional loans and debt relief. In order to maintain external debt at sustainable level, the government will not contract or guarantee external debt on nonconcessional terms, and will not accumulate external payments arrears.

H. Concluding Remarks

47. Significant progress has been made in the sphere of fiscal, monetary and structural issues in the context of the current PRGF which is due to end after completion of the sixth review. Even though the Bank of Tanzania foreign exchange reserves are now adequate to meet the requirements of the foreign exchange markets, significant risks remain. In this context, the Government of Tanzania considers the continuation of IMF engagement through a three - year low access PRGF arrangement to be valuable for continued economic progress. We would therefore like to request this arrangement beginning in fiscal year 2003/04 and we intend to continue consultation with the Fund on Tanzania's economic and financial policies in accordance with such an arrangement.

48. The Government of Tanzania will provide the Fund with such information as the Fund requests in connection with Tanzania's progress in implementing the economic and financial policies and achieving the objectives of the program. During the arrangement period, Tanzania will consult with the Managing Director of the Fund on the adoption of any measures that may be appropriate, at the initiative of Tanzania or whenever the Managing Director requests such consultation. Moreover, after the period of the arrangement and while Tanzania has outstanding financial obligations arising from loans under the arrangement, Tanzania will consult with the Fund from time to time at the initiative of the Government or whenever the Managing Director requests consultation on Tanzania's economic and financial policies.

Sincerely,

Technical Memorandum of Understanding on Selected Concepts and Definitions Used in the Monitoring of the PRGF-Supported Program

July 10, 2003

Introduction

1. The purpose of this Technical Memorandum of Understanding (TMU) is to describe concepts and definitions that are being used in the monitoring of the quantitative performance criteria and benchmarks under the Poverty Reduction and Growth Facility (PRGF)-supported program, as laid out in Table 3 of the government's letter of intent of July 10, 2003 to which this TMU is attached.

Net international reserves

2. Net international reserves (NIR) of the Bank of Tanzania (BoT) are defined as reserve assets minus reserve liabilities. The BoT's reserve assets include (i) monetary gold; (ii) holdings of SDRs; (iii) the reserve position at the IMF; (iv) holdings of foreign exchange; and (v) other liquid and marketable assets readily available to the monetary authorities. Reserve assets exclude assets pledged or otherwise encumbered, including but not limited to assets used as collateral or guaranteed for a third-party external liability (assets not readily available). The BoT's reserve liabilities include (i) all short-term foreign exchange liabilities to nonresidents , and (ii) all liabilities to the IMF. Reserve liabilities exclude medium and long-term foreign liabilities.

Net domestic assets and reserve money

3. Net domestic assets (NDA) of the BoT are defined as the BoT's reserve money minus its net foreign assets (NFA). Reserve money is defined as the sum of currency issued by the BoT and the deposits of the commercial banks with the BoT. Net foreign assets (NFA) of the BoT consist of its NIR, net other foreign assets, and its medium- and long-term foreign liabilities. For purposes of deriving NDA from reserve money and NFA, the latter are converted into Tanzania shillings at the program exchange rate.

Net domestic financing of the government of Tanzania

4. Net domestic financing of the Government of Tanzania (NDF) includes financing by the banking system (BoT and commercial banks) and the nonbank public of the budget of the central (union) government of Tanzania. NDF is calculated as the cumulative change since the beginning of the fiscal year in the sum of (i) loans and advances to the government by the BoT (excluding liquidity paper issued by the BOT for monetary policy purposes) minus all government deposits with the BoT; (ii) loans and advances to the government by the commercial banks minus all government deposits held with the banks; and (iii) the outstanding stock of domestic debt to nonbanks excluding government debt issued for the recapitalization of the NBC and the NMB, and debt of parastatal companies assumed by the government.

External payments arrears

5. External payments arrears consist of the total amount of external debt service obligations (interest and principal) of the government and the BoT that have not been paid at the time they are due, excluding arrears on external debt service obligations pending the conclusion of debt-rescheduling arrangements.

Contracting or guaranteeing of external debt on nonconcessional terms

6. The term "debt" will have the meaning set forth in Point 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 (Decision No. 12274-(00/85)). Government debt is outstanding debt owed or guaranteed by the Government of Tanzania or the Bank of Tanzania (but does not include debt of any political subdivision or government-owned entity with separate legal personality that is not otherwise owed or guaranteed by the Government of Tanzania).
   
   
7. Government debt is considered nonconcessional if the grant element is lower than 35 percent, calculated using discount rates based on Organization for Economic Cooperation and Development (OECD) commercial interest rates (CIRR), adjusted as appropriate for different maturities. This performance criterion applies not only to debt as defined in Point 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 (Decision No. 12274-(00/85)), but also to commitments contracted or guaranteed for which value has not been received.

Budgetary arrears

8. New budgetary arrears are defined as arrears accumulated during the fiscal year on wages, domestic interest, and goods and services.

Foreign program assistance

9. Foreign program assistance is defined as grants and loans received by the Ministry of Finance through BoT accounts and is calculated as the cumulative sum, since the beginning of the fiscal year, of the receipts from (i) program loans and (ii) program grants.

Adjusters

10. The quantitative targets for the BoT's net international reserves will be adjusted downward for any shortfall in foreign program assistance.
    
    
11. The quantitative limits on the BoT's net domestic assets will be adjusted upward for any shortfall in foreign program assistance converted into Tanzania shillings at the average quarterly exchange rate.
    
    
12. The quantitative limits on net domestic financing of the Government of Tanzania will be adjusted upward for any shortfall in foreign program assistance converted into Tanzania shillings at the average quarterly exchange rate.

Data Reporting Requirements

For purposes of monitoring the program, the government of Tanzania will provide the data listed below.

13. Reporting of developments in relation to the program's benchmarks and performance criteria to be provided monthly:

Table of Quantitative Performance Criteria and Benchmarks (Table 3).

Table with the Structural Benchmarks and Performance Criteria (Table 4). The column of this table, labeled "Status," will be updated on a monthly basis with a view to monitor progress with the structural benchmarks and performance criteria.

Table on priority sector expenditure targets and performance.

14. Other Data to be provided monthly, quarterly, or other frequency of compilation:

The balance sheet of the BoT.
The consolidated balance sheet of the commercial banks.
The monetary survey.
Commercial banks—domestic lending by borrowing sectors.
Commercial banks—interest rate structure.

The flash report on revenues and expenditures.
The TRA revenue report.
The Monthly Domestic Debt Report.
Monthly report on Central Government Operations.

The external cash flow statement, including details on payments of interest and principal on government external debt.
Exports and Imports.
Balance of payments:

The published consumer price index report of the National Bureau of Statistics (NBS).

The quarterly and annual national accounts statistics in constant and current prices as prepared by the NBS.