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

Tirana, January 9, 2004

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

Dear Mr. Köhler,

The Poverty Reduction and Growth Facility (PRGF) arrangement, which was approved in June 2002, has been instrumental in promoting macroeconomic stability and economic growth, and improving governance in Albania.

All quantitative performance criteria under the program have been observed. We met, as a prior action for completion of the third review, the actions specified in the end-September 2003 structural performance criterion on the settlement of public sector inter-enterprise arrears. As the short delay does not compromise program objectives, we request a waiver for the non-observance of this performance criterion, and request completion of the third review as well as the financing assurances review under the arrangement.

The attached supplementary Memorandum of Economic and Financial Policies (MEFP) and the Technical Memorandum of Understanding (TMU) describe our economic program for the period ahead. These policies are consistent with our November 2001 National Strategy for Socio-Economic Development (NSSED) and the May 2003 Annual Progress Report.

We believe that the policies set forth in the attached MEFP are adequate to achieve the objectives of its program, but will take any further measures that may become appropriate for this purpose. Albania will consult with the IMF on the adoption of such measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the IMF's policies on such consultation.

Moreover, after the end of this arrangement and while Albania has outstanding financial obligations to the IMF arising from loan disbursements under this arrangement, Albania will consult with the IMF from time to time on economic and financial policies, at the initiative of the Government or Bank of Albania or whenever the Managing Director of the IMF requests such consultation. These consultations may include correspondence and visits of officials of the IMF to Albania or of representatives of Albania to the IMF.

In continuing with our policy of transparency, we consent to the publication of this letter, the attached MEFP, and the accompanying Executive Board documents on the IMF's website.

Sincerely yours,

Supplementary Memorandum on Economic and Financial Policies (MEFP) of the Government of the Republic of Albania for 2003-04

I. Background

1. This memorandum reviews the implementation of the PRGF-supported program, updates the macroeconomic framework for 2004-06, and lays out our policies for the period December 2003-June 2004. It is consistent with the November 2001 National Strategy for Socio-Economic Development (NSSED) and the May 2003 progress report; and supplements the June 2002, January 2003, and June 2003 MEFPs.

II. Performance under the Program

2. Macroeconomic developments during 2003 have been encouraging. Economic growth has strengthened from an estimated 4.7 percent in 2002 to an estimated 6 percent, while a cautious monetary policy stance has contributed to the maintenance of low inflation (3.4 percent in November). Our external position strengthened during the first nine months of 2003, reflecting a pick-up in export of goods and services, while the exchange rate underwent some nominal appreciation.

3. Fiscal discipline was also maintained, albeit in a less than optimal manner. Budget targets for domestic borrowing and the overall deficit were met. However, tax revenue continued to fall short of the indicative targets—by ¾ percent of GDP in September—although it was ¾ percent of GDP higher than during the same period in 2002. This shortfall required offsetting action on the expenditure side, in line with the contingency plans prepared in June 2003, consisting mainly of discretionary savings on electricity subsidies (helped by improved supply conditions) and personnel spending. In addition, expenditure on foreign financed projects is estimated to have fallen about 1 percentage point of GDP short of planned levels, indicating the importance of addressing problems related to donor-financed activities. Strong GDP growth and ongoing fiscal consolidation—together with debt forgiveness—reduced public debt to an estimated 61 percent of GDP in 2003 from 74 percent in 2000.

4. We met all end-September 2003 quantitative performance criteria (PCs) under the program. The floor for net international reserves of the BoA and the ceiling on net domestic assets of the BoA were observed by comfortable margins. The actual level of contracted and guaranteed nonconcessional debt was lower than the ceiling, reflecting difficulties in prioritizing projects and in getting more favorable conditions from creditors. No new external payment arrears were accumulated, excluding interest on pre-existing arrears.

5. On public sector inter-enterprise arrears, we carried out the required measures stipulated in the end-September PC in December 2003 as a prior action for completing this review. We executed the government-assisted netting and final settlement of the end-December 2001 stock of arrears in November, and finalized a draft strategy for ensuring the full and timely payment of all subsequent obligations. These actions represented important steps towards normalizing fiscal relations and improving transparency and budgetary revenue collection.

6. We have improved policy implementation and made progress in carrying out the policies described in our June 2003 Supplementary MEFP. In addition to actions carried out in relation to the 2004 budget, which are described in Text Tables 1 and 2, we completed the following measures.

• To improve tax administration, we enacted a new excise law; transferred responsibility for the collection of social insurance contributions for large taxpayers to the General Directorate of Taxation (GDT); [ensured that the Social Insurance Institute (SSI) assigned social insurance numbers for all employees for the firms registered in the Large Taxpayer Unit]; and brought on line a new computer system for profits tax. We also separated the internal audit services and the internal investigation services of the GDT into two distinct structures. The GDT has started to provide monthly reports on total VAT refunds paid.
  
  
• We instituted significant reforms and organizational changes within the General Directorate of Customs (GDC). The GDC has continued to prepare quarterly reports on corrective measures to deal with problems identified by the internal audit function. We have also approved the enabling legislation to establish tax policy and revenue forecasting units in the Ministry of Finance (MoF). The post-clearance control unit of the GDC was established in July, fully empowered with the legal competence to perform its functions and conduct off-site audits (SB; end-July).
  
  
• As part of our strategy to strengthen the business environment, we completed an action plan for the removal of administrative barriers to investment. We abolished licensing requirements in the non-food sector, and we also met all targets under the electricity sector action plan.
  
  
• To improve governance, we established and funded the Office of Asset Declaration, which has begun implementing the law on asset declaration. We also strengthened tax appeal procedures (SB; end-December 2003); and reviewed and strengthened anti-money laundering legislation.
  
  
• Regarding our remaining external arrears, we submitted to Parliament agreements with Hungary (SB; end-December) and Macedonia. Negotiations with the Czech and Slovak Republics, Romania, Poland, and commercial creditors are ongoing. The MoF has prepared a timetable for rescheduling remaining external arrears, subject to cooperation of the creditors. The MoF continues to report external arrears data to the IMF on a regular basis (SB; ongoing).
  
  
• In the statistical area, we published full documentation of the methodology and data sources for our new national accounts; and introduced a new law on statistics to Parliament designed to provide our statistics agency with better access to source data.

7. However, some measures were not completed within the planned time frame.

• Settlement of the remaining claims of Albtelekom (SB; end-September) was not finalized, notwithstanding our good faith efforts, due to a delay in negotiations with a major counterpart.
  
  
• The scheduled auctioning of the fiscal functions of the Savings Bank in 5 cities (SB; end-December) was converted into the full liberalization of these services at the beginning of 2004. Regional treasury offices and government agencies are now empowered to select any bank offering such services to act as their fiscal agent.
  
  
• Although we instituted the reporting of VAT refunds and opened the VAT account shortly after the deadline (SB end-June), related procedures are still being established.
  
  
• We have not completed the process of redrafting the VAT and customs laws and regulations to ensure consistency (SB; end-December), but expect to do so in time for the presentation of the 2005 budget (revised SB; end-October 2004).
  
  
• The computerization of the Tirana Treasury office was not completed on time, but will be finished by February 2004.
  
  
• We did not introduce a simplified registration procedure for the small business tax as part of the 2004 fiscal package (SB: end-March 2004), but will do so in early 2005, in order to have an updated registry of small businesses at the time when social contribution collections from small businesses are transferred to the GDT.

III. Policies and Measures for January-December 2004

A. Overall Strategy

8. As we enter the second half of the 3-year PRGF arrangement, our overall program strategy is broadly unchanged. Our macroeconomic and structural policies remain predicated on the belief that improvements in the business climate, leading to sustainable, high-quality, private sector-led growth, are essential for reducing poverty. At the same time, we are committed to pursuing greater efficiency and equity in the mobilization and use of resources so as to increase our capacity to provide essential poverty-reducing services such as health care, education, and social protection. Common to all our policies is a strong focus on fighting corruption, strengthening institutional capacity, improving governance, reducing informal activity, and enhancing dialogue with all stakeholders.

B. Macroeconomic Framework

9. A favorable, but realistic, macroeconomic framework is assumed for the remainder of the program period. Supported by rising investment, and improvements in the business environment, real GDP growth is expected to continue at 6 percent, while monetary policy, supported by a flexible exchange rate regime, will focus on maintaining inflation in the 2-4 percent range. Ongoing reforms to enhance the efficiency of tax administration, combined with a concerted effort to reduce the size of the grey economy, will increase total revenue as a share of GDP and permit an expansion of priority expenditure within a framework of further fiscal consolidation. Following a 1¼ percentage point of GDP reduction in 2003, the overall budget deficit (including grants) will fall by a further ¾ percentage point of GDP to 4¼ percent by 2006, which will facilitate a decline in public debt from an estimated 61 percent of GDP in 2003 to 57½ percent in 2006. Aided by rising exports, the fiscal consolidation will support a 1¾ percentage point of GDP decline in the current account deficit to 6¾ percent by 2006. Reserve cover will remain above 4 months of imports of goods and services.

C. Fiscal Policy

10. The 2004 budget projects the overall deficit (including grants) to broadly stabilize at about 5 percent of GDP, and domestic borrowing to remain unchanged at 2¾ percent of GDP. The overall deficit in 2004 is about 1 percentage point below the level foreseen in the 2002-05 MTEF, while domestic borrowing is set ½ percentage points above the MTEF level, in order to help protect road and other infrastructure expenditure, and to mitigate the effect of past and present shortfalls in foreign project financing. Quantitative performance criteria for March 2004, and indicative targets for June have been set as ceilings on net domestic credit to the government. Parliament has approved the 2004 budget as a prior action for completion of the third program review.

11. Tax revenues are projected to be 20¾ percent of GDP in 2004, about ¾ percentage points of GDP higher than the 2003 estimated outturn. The increase is predicated primarily on specific tax measures, in particular, the full-year effect of the introduction of the new excise law in July 2003, reform of the social security system, and the imposition of new environmental taxes at the beginning of 2003. The budget also includes offsetting tax measures to compensate for expected revenue losses arising from our WTO commitments to lower tariffs, and our agreement with the EU and the IMF to transform the components of the road tax into changes in the excises on diesel and gasoline, and an additional tax on vehicles, without increasing the tax burden.

12. The 2004 budget does not assume any privatization receipts from the sale of Albtelekom or the Savings Bank. Should such receipts materialize, we may spend part of it in 2004 on well-conceived investment projects in priority areas as identified in the NSSED and the recently updated Medium-Term Budget Program (MTBP)¹. The supplementary budget for this expenditure would be formed in close consultation with IMF staff.

13. To help manage downward risks to the revenue projections and protect priority spending, the release of part of the reserve fund and contingency fund in 2004 will be made dependent on the revenue outturn for 2003. In particular, up to Lek 1 billion of the reserve fund and up to Lek 1 billion of the contingency fund will not be available for expenditures to the extent that the final revenue collected in 2003 by the GDT, GDC, and SSI (including taxes collected on behalf of local governments) falls short of the current end-2003 projection of Lek 144.5 billion. Should such a shortfall occur, the government will adopt a formal decision to limit expenditure in this manner and to this extent (SB; end-June 2004). If the 2003 shortfall exceeds Lek 2 billion, we will execute further reductions in non-priority spending, in particular in administration costs. In addition, in the context of the fourth review, we will discuss the available 2004 revenue data with IMF staff and agree an appropriate response. This approach will serve to avoid haphazard reductions in expenditure and the corresponding adverse impact on priority spending.

14. Reform of tax administration remains a cornerstone of our fiscal strategy. The mobilization of additional resources through efficiency gains and through a broadening of the tax net is essential to reduce the burden on current taxpayers and expand the delivery of priority services. Over the remainder of the program period, reforms in this area will focus on strengthening information systems, auditing procedures, and incentive systems; enhancing cooperation among the GDT, the GDC, and the SSI; and improving taxpayers relations, including by further strengthening the appeals process, avoiding excessive audits, and providing more comprehensive information on regulations and procedures. We will not introduce any fiscal schemes that would undermine tax compliance or raise the potential for money laundering and other illegal activities. We will complete the specific measures described in Text Table 1.

15. We are pushing ahead with the implementation of ASYCUDA. We had originally intended that the system would be installed in the Tirana customs office and the Durrës port by end-January 2004. We still expect it to be fully operational in Tirana by this deadline, and propose an end-January 2004 performance criterion to this effect. However, technical and administrative difficulties will likely delay the process in the Durrës port. Accordingly, we propose an additional performance criterion, making the system fully operational in Durrës and initiating an integrity audit of the system in both Tirana and Durrës (as recommended by the EU CAM-A project) be set for end-March 2004. Transit procedures between Durrës and Tirana would then be completed by end-May 2004. The recommendations of the audit will be adopted by the Tirana customs office and the Durrës port (new SB; end-June 2004) before the final roll out phase begins.

16. Ongoing expenditure measures, summarized in Text Table 2, focus on further increasing the efficiency and transparency of spending; and on further reorienting expenditures towards priority areas. We will ensure that expenditure on health care and education will be increased in 2004, as planned in the budget and in line with the 2004-06 MTBF. The wage bill will rise no faster than nominal GDP. There will be no earmarking of revenues for specific capital expenditures (such as for the Durrës-Kukes road project) within the budget. We will use the reserve and contingency funds sparingly and only in case of emergencies.

Text Table 1: Tax Administration and Policy Reforms

Measures introduced in the context of the 2004 budget

Amend the law on tax procedures to obligate the tax administration to inform the public on tax changes.

Prepare and implement a tax form that requires firms to declare all social security contributions and personal income tax withheld.

Require all firms, including all firms benefiting from income tax exemptions, to have a tax registration number and to file an income tax report.

Eliminate estimated transportation costs from the VAT base.

Other measures

Improve fiscal reporting by completing the computerization of regional treasury offices (SB; End-September 2004).

Improve the VAT refunds process by reporting on the stock of VAT refunds claimed and refunds paid out every month (SB; End-March 2004, and ongoing).

Continue to increase the number of active, registered taxpayers from 48,000 at end-September 2003.

Continue the transfer of collection social security contributions to GDT in line with the July 2003 FAD technical assistance report (ongoing).

Ensure that the SSI will have a system providing individual level data on contributions paid and benefits received by end-December 2004.

Study the modalities of harmonizing the definition of gross employment income and the withholding mechanisms in the personal income tax law and the law on social security contributions in conjunction with the upcoming IMF technical assistance mission. Institute the change within 2004, in time for inclusion in the 2005 fiscal package.

Implement the new computer administration system for social insurance contributions by end-May 2004.

Define excise duties on alcohol in terms of liters of alcohol, rather than in liters of liquid, as part of the 2005 fiscal package.

Disseminate publicly the procedures for the initiation and conduct of enforced collection action; and for ensuring timely VAT refunds. Strengthen the appeals processes for the tax and customs administrations further by automatically granting the request to the taxpayer if the tax administration does not respond to the request within 30 days.

Implement strictly the requirements on the use of cash registers (ongoing).

17. We will strictly implement the strategy for settling public sector inter-enterprise arrears and for preventing the emergence of new ones. We will ensure both full and timely execution of the payments schedule for the stock of end-December 2001 arrears; and the rapid regularization of any arrears that occurred subsequent to this date or arise during the program period. A new unit at the Ministry of Economy (MoE) has been created to monitor scheduled payments as well as all subsequent overdue obligations, and this unit will report all instances of nonpayment in a public quarterly report. The MoE will be responsible for initiating prompt remedial action. We will complete a study on introducing incentives for responsible financial behavior by the water companies by end-June 2004.

Text Table 2: Expenditure Measures

Measures introduced in the context of the 2004 budget

Limit the maximum allowable transfer of one spending agency's appropriation to another without the consent of parliament to 7 percent.

Present the 2004 budget to Parliament with capital expenditure by project; and require approval by Parliament on a program basis.

Formulate guidelines on standards and norms for all budgetary institutions to enhance fiscal responsibility and accountability.

Measures to be introduced in the context of the 2005 budget

Increase the accountability and transparency of the budget process, including by provisions to gradually bring the budget process forward, beginning in 2005, to give Parliament more time for review; and to further expand the appropriations structure in the 2005 budget to include object/economic classification of recurrent expenditure (End-October 2004).

Limit the maximum allowable transfer of one spending agency's appropriation to another without the consent of parliament to 5 percent.

Expand the appropriation structure in the budget document to cover object/economic classifications of recurrent expenditure programs.

D. Monetary Policy

18. Monetary policy will continue to aim at keeping inflation in a 2-4 percent target range. We will investigate the possibility of focusing on average inflation in addition to, or instead of, end-year annual inflation, as this could allow us to concentrate more on underlying trends and reduce the influence of strong seasonal factors on policy. We will also continue to monitor complementary indicators such as core inflation and money growth, as the monetary transmission mechanism and inflation dynamics remain unclear. The repo rate will remain our key policy instrument, and we will seek to further improve its impact on market rates through supportive monetary management, including open market operations. These operations will also be guided by our monetary program to ensure consistency between monetary and inflation objectives and the agreed fiscal deficit target. We will conduct further research on the determinants of inflation in the context of our preparations for moving to formal inflation targeting over the medium term with the help of MFD technical assistance. We will maintain a flexible exchange rate regime, with selective interventions aimed at smoothing short-term deviations from long-term trends and meeting NIR targets set within the monetary program. We will ensure that the legal and operational independence of the BoA is not compromised.

19. The monetary program seeks to maintain continued monetary stability, inflation in line with the target, and a reserve-to-import ratio in 2004 of about 4 months. Velocity is projected to remain broadly stable. Quantitative performance criteria for March 2004, and indicative targets for June have been set as a ceiling on net domestic assets of the Bank of Albania, and as a floor on net international reserves.

20. The BoA will continue to strengthen banking supervision in the context of the Supervisory Development Plan prepared in consultation with the World Bank. Technical assistance will be provided by the new MFD resident advisor.

21. The BoA will strengthen its control, accounting, and auditing systems in line with the July 2002 safeguards assessment report. It will continue to cooperate with the safeguards policy and provide updated documents and data as necessary.

E. Structural Policies

22. Improving governance in general, and fighting corruption in particular, remain key priorities within our broader strategy for supporting private sector activity and economic growth. In this context, policies have been developed in consultations with the World Bank and the EU. These include: (i) efforts to enhance the professionalism and motivation of public sector personnel; (ii) measures to limit the scope for corruption by reducing discretion and ensuring clear and consistent regulations; (iii) the setting of high standards for public sector workers; and (iv) the application of credible and resolute action against abuse. In addition to the governance-related measures included in Text Tables 1 and 2, specific actions will include:

• Complying strictly with existing conflict of interest legislation contained in Chapter 2 of the new Law on Code of Ethics in Public Administration: and preparing a study of existing legislation by end-February 2004, in consultation with the World Bank, to decide whether a separate law on conflict of interest of public officials is necessary.
  
  
• Adopting a new insurance law with a transparent regulatory regime (end-March 2004).
  
  
• Complying strictly with the Civil Service Law and related legislation and the draft code of ethics in hiring and firing policies for high level government officials. In consultation with the World Bank, extend the civil service law, or its equivalent, to selected central government organizational units, with priority given to GDT, GDC, and INSTAT (SB; June 2004).
  
  
• Expanding the operations of the High Inspectorate charged with implementing the law on asset declarations by public officials. In particular, the staffing will be completed and effective procedures developed for processing and verifying declarations.
  
  
• Reinforcing our efforts to combat money laundering, in particular, by conducting a comprehensive self-assessment of our laws, regulations, institutions and practices in this area, in cooperation with the MFD resident advisor at the BoA (end-June 2004).

23. The current initiative for removing administrative barriers to investment presents a unique opportunity to significantly improve the business climate, strengthen the export sector, and attract foreign and domestic investors. Key barriers identified by FIAS include arduous licensing and tax procedures, lack of transparency in policy implementation, abuse of power by officials, and weak law enforcement. We developed an action plan in 2003 to implement remedial policies supported by corresponding, measurable indicators. Over the course of 2004, we will fully implement the action plan (SB; end-June 2004) in close consultation with the business community. To create better conditions in the agricultural sector, we will introduce a law to regulate land ownership and establish offices for land in every district. We will not introduce firm- or industry-specific financial or tax incentives to promote investment, and will improve credit provisioning through a new accounting law for enterprises and through improvements in the registry for collateral.

24. The privatization process for large enterprises will be accelerated, concentrating mainly on Savings Bank, Albtelekom, and INSIG. We hope to finalize negotiations with a strategic investor in the Savings Bank by mid-2004. We will seek to ensure that the privatization of the Savings Bank does not endanger the continued provision of banking services throughout the country. We confirm that the bank will not embark on extending credit (other than to the government) before privatization except, possibly, on a pilot basis and with the prior approval of the BoA and World Bank and IMF staff. To help prepare Albtelekom for privatization, we will make good faith efforts to finalize the settlement of the remaining financial claims before end-March 2004. As a pre-privatization action, 39 percent of INSIG has been sold to the EBRD and IFC. We expect the remaining government shares to be sold to a strategic investor sometime in 2004 or 2005.

25. Improving the provision of electricity will be key to promoting private sector growth. For this goal, and to help ensure that import subsidies can be held to Lek 1.5 billion in 2004 before being phased out completely in 2005, we will adhere to the performance targets of the sectoral action plan for 2004-05. In addition, we will:

• Not grant new lower prices as incentives to investors and will reduce differentiation of prices among different groups of customers. In particular, reduced electricity prices for public sector agencies (other than the water companies) will be eliminated by the end of 2005.
  
  
• Complete the installation of meters by end-2004.
  
  
• Maintain the MoF's responsibility for ensuring full payment of electricity fees for water companies.
  
  
• Prepare a proposal on whether, and if so, under what conditions, KESH should continue to collect the television license fee and the road cleaning fees (end-June 2004).
  
  
• Introduce a new targeted subsidy, in the context of the 2004 budget, fully paid for by government, to offset the impact of higher electricity prices on poor households.

26. Financial sector reform will be aimed at improving the transparency and efficiency of financial markets. We will promote the sale of treasury bills to the general public, including through Albapost, by exploring various options including the possibility of selling smaller denominations. We will further promote the use of the banking system for payments, particularly salaries, through a publicity campaign; and through the inauguration of the RTGS system before end-March 2004 and a bulk settlement system by end-September 2004. Furthermore, at least 10 percent of government employees will receive their salary through the banking system by September 2004. With respect to the stock exchange, while we will not assign it responsibility for the primary treasury bill market, the possibility of it serving as the main platform for secondary market sales will be explored. We will also examine the scope for it to trade in company shares, on the basis of a World Bank-sponsored study. The credit guarantee scheme and plan for providing soft loans to small and medium-sized enterprises will be presented to the World Bank and IMF staff for comments before adoption. We will request an official sovereign rating by the end of 2004.

F. External Policies

27. We will continue negotiations on the Stabilization and Association Agreement, an important goal of which is to achieve an Albania-EU free trade area. We are currently discussing the reduction of tariffs on industrial goods based on commitments negotiated with the WTO. In November 2003, we started discussions on further reducing tariffs on agricultural goods. We will carefully assess the revenue impact of future trade liberalization. As part of the negotiations with the EU, we have committed to combating corruption and organized crime and to giving this objective priority within the government agenda.

28. We also continue to enhance regional cooperation. We have already ratified free trade agreements with Macedonia, Croatia, Kosovo, Romania, Bulgaria, and Bosnia and Herzegovina. The agreements with Macedonia, Croatia, Kosovo, and Bulgaria are already effective. Free trade agreements with Serbia and Montenegro and Moldova have been agreed at the ministerial level.

29. We have made progress in reducing external arrears to official creditors and remain committed to eliminating them completely by the end of 2005. Following the rescheduling agreement on post-1978 arrears with China in 2002, we finalized rescheduling agreements with Hungary and Macedonia. The agreement with Hungary has been submitted to Parliament for ratification (SB; end-December 2003). Progress in settling official arrears in nonconvertible currencies has been slower due to the difficulty in finding an agreement on the exchange rate, but negotiations with creditors to reconcile amounts due are continuing.

30. We will strengthen the recording, monitoring, and projecting of donor financing activities. We have established an interministerial working group chaired by the deputy prime minister. During 2004 we will complete the reorganization of these functions to avoid duplication of effort among ministries and to achieve better coordination. To ensure the success of this exercise we will seek the cooperation of the donor community, in particular to provide data on past disbursed grants and projected foreign aid.

31. We will improve the evaluation and prioritization of non-concessional, foreign-financed investment projects. They will be assessed within the context of the corresponding sectoral strategies as outlined in the NSSED and MTBP. We will establish and follow transparent, competitive procedures for negotiating and selecting favorable supply and lending agreements, pursuant to international practices and procedures and Albanian legislation. In this context, new large-scale projects will, in principle, be subject to international open tenders and will be executed only if (i) overall ceilings to non-concessional borrowing are respected; (ii) independent feasibility studies of international standards are prepared; and (iii) favorable financial terms are secured. We will inform the IMF on a quarterly basis on the list and status of projects being considered for non-concessional financing (SB, ongoing); and we will conduct an independent feasibility study for any new large project (SB, ongoing).

G. Data Issues

32. We recognize the need to redouble our efforts to address weaknesses in the quality and coverage of economic statistics, which continue to seriously hamper monitoring of developments and sound policy analysis. In cooperation with our technical assistance providers, including a resident advisor facilitated by STA, we will improve the scope and collection of data on private remittances, real sector activity indicators and national accounts, with particular attention to the assessment of informal activity. We will employ surveys and other tools to improve our statistics on foreign direct investment through comprehensive coverage of at least the largest enterprises. We will also ensure the provision of adequate resources to INSTAT, as well as its inclusion under the Civil Service Law (or a comparable framework) during 2004.

H. Program Monitoring

33. The fourth review under the PRGF-supported program will be based on end-March 2004 quantitative PC's and end-June 2004 indicative targets (Table 1 and the TMU) and the end-January 2004, end-March 2004 and end-June 2004 structural conditionality (Table 2). PC's and indicative targets for end-September 2004 and end-December 2004 will be set at the time of the fourth review. During the program period, Albania will not impose or intensify restrictions on the making of payments and transfers for current international transactions, or introduce multiple currency practices, or conclude bilateral payments agreements inconsistent with Article VIII, or impose or intensify import restrictions for balance of payments reasons. We will present a new progress report on the NSSED by April 2004, taking into account the recommendations of the joint staff assessment of the 2003 progress report.

ALBANIA

Technical Memorandum of Understanding

1. This memorandum defines the quantitative benchmarks and performance criteria established in the Memorandum of Economic and Financial Policies (MEFP) for December 2003-September 2004.

A. Net Domestic Credit to the Central Government

2. For the purposes of the program, the central government covers the State Budget, the Social Security Institute (SSI), and the Health Insurance Institute (HII).

3. Net domestic credit to the government (NCG) is defined as the sum of domestic credits in lek and in foreign currency, except for onlending of foreign project loans to all parts of the central government as defined above, including Treasury bills and bonds held by the Bank of Albania, domestic commercial banks, and other domestic lenders (including insurance companies, other firms, and households), less the sum of central government deposits with the banking system (but excluding foreign currency deposits related to foreign financed projects), and the deposits of the SSI and the HII.¹ Credits comprise bank loans and advances to the government (excluding advances on profit transfers by the Bank of Albania), holdings of government securities, due but unpaid interest, and negative balances in government deposits with banks.

4. The component of the domestic credit to government in the form of securities will be calculated based on data on their outstanding stock valued at issue price, with the adjustment for the amount held by the units of central government as defined above (in particular, the SSI and the HII). Sales of Treasury bills will be counted at discounted value. Reported repayments of Treasury bills and other government securities will not include interest payments, either as coupon interest or the discount. Those components of net domestic credit to the government denominated in foreign currencies are to be valued as stipulated in the GFS. Data on other components of credit to government, if any, will be reported by the Bank of Albania.

5. According to the above definition, the level of net domestic credit to government was Lek 259.8 billion at end-December, 2002.² Gross loans were composed of (i) total outstanding T-bills at issue price in the amount of Lek 265.2 billion, of which Lek 74.5 billion was held by the Bank of Albania, Lek 175.9 billion by commercial banks, and Lek 14.8 billion by other domestic lenders; and (ii) other government lek securities, loans, and other claims on government in the amount of Lek 3.6 billion. From these gross loans, the following items were deducted: (i) central government deposits (excluding social security funds) in the amount of Lek 2.8 billion; and (ii) SSI and HII deposits and T-bill holdings in the amount of Lek 6.2 billion.

6. The limits on the change in net domestic credit to the government will be cumulative from end-December 2002.

B. Net Domestic Assets

7. The net domestic assets (NDA) of the Bank of Albania are defined as the difference between reserve money—defined as the sum of currency issue (less lek notes and coins held by the Bank of Albania) and commercial bank reserves held by the Bank of Albania—less the net international reserves of the Bank of Albania (Section C), with all foreign currency assets and liabilities valued in local currency for program monitoring purposes at an exchange rate at end-December 2001. Under this definition, the level of the NDA was Lek 87.1 billion as of end-December 2002. The NDA limits will be cumulative changes from end-December 2002 and will be monitored from the accounts of the Bank of Albania.

C. Net International Reserves

8. Net international reserves (NIR) are defined as reserve assets minus reserve liabilities of the Bank of Albania. Reserve assets are readily available claims of the Bank of Albania on nonresidents denominated in foreign convertible currencies, and held for the purpose of meeting balance of payments financing needs, intervention in exchange markets, and other purposes. They include Bank of Albania holdings of monetary gold, SDRs, Albania's reserve position in the IMF, foreign currency cash, and deposits abroad. Excluded from reserve assets are any assets that are pledged, collateralized, or otherwise encumbered; claims on residents; precious metals other than monetary gold; assets in nonconvertible currencies; illiquid assets; and claims on foreign exchange arising from derivatives in foreign currencies vis—vis domestic currency (such as futures, forwards, swaps, and options). Reserve liabilities shall be defined as foreign exchange liabilities to residents and nonresidents of the Bank of Albania, irrespective of their maturity. They include: foreign currency reserves of commercial banks held at the Bank of Albania; all credit outstanding from the IMF; commitments to sell foreign exchange arising from derivatives (such as futures, forwards, swaps, and options); and all arrears on principal or interest payments to commercial banks, suppliers, or official export credit agencies. Excluded from reserve liabilities are the government's foreign currency deposits at the Bank of Albania.³ Reserve assets and reserve liabilities will both be expressed in U.S. dollars.

9. During this program, for monitoring purposes, the exchange rates of the SDR and non-dollar currencies will be kept at their end-December 2001 levels and holdings of monetary gold will be valued at SDR 35 per ounce. Excluded from gross international reserves are holdings of nonconvertible currencies, claims on nonresident financial institutions denominated in nonconvertible currencies, and other claims which are not readily available.

D. Adjusters for NCG, NDA, and NIR

10. The NCG and NDA ceilings and the NIR floor are defined on the assumption that total privatization proceeds (privatization proceeds received in foreign currency)⁴ will amount, on a cumulative basis, from January 1, 2004, to:

End-March 2004 Lek 1,355 million, (Lek 0.0 million, US$0.0 million)

End-June 2004 Lek 3,215 million, (Lek 1,860 million, US$15.5 million)

The NIR floor will be adjusted upward (downward) and the NDA ceiling adjusted downward (upward) by any excess (shortfall) in the receipt of privatization proceeds in foreign currency from these assumed values. The NCG ceiling will be adjusted upward (downward) by half the amount of the shortfall (excess) in the receipt of total privatization proceeds from these assumed values.

11. The ceilings on NCG and NDA, and the floor on NIR are defined based on the assumption that foreign budgetary and/or balance of payments financing (excluding IMF

financing and project and commodity loans or commodity grants, or other aid) will amount, on a cumulative basis, from January 1, 2004, to:

End-March 2004 US$0.0 million (of which grants: US$0.0 million)

End June 2004 US$0.0 million (of which grants: US$0.0 million)

In cases where total foreign loan financing exceeds this projection, the ceilings on NDC to the government and NDA of the Bank of Albania will be adjusted downward, and the floor on NIR will be adjusted upward. In cases where total foreign grant financing exceeds this projection, the ceiling on NDA of the Bank of Albania, the floor on NIR of the Bank of Albania, and the ceiling on NDC to the government will remain unchanged.⁵

12. The NDA ceilings will be also adjusted to reflect the impact of any change in the required reserve ratio of commercial banks with the Bank of Albania.

E. External Debt and Arrears

13. As set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-00/85) August 24, 2000), the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property. Arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

14. The limit on medium- and long-term external debt applies to the contracting or guaranteeing by the central government or the Bank of Albania, 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. It applies not only to debt as defined in paragraph 12 of this memorandum, but also to commitments contracted or guaranteed for which value has not been received. External debt will be considered to have been contracted at the point the loan agreement or guarantee is ratified by the Albanian parliament. Excluded from the limits are refinancing credits and rescheduling operations (including the deferral of interest on commercial debt), credits extended by the IMF, and credits on concessional terms defined as those with a grant element of at least 35 percent. The grant element is to be calculated using the OECD Commercial Interest Reference Rates (CIRRs): for maturities of less than 15 years, the grant element will be calculated based on six-month averages of CIRRs; and for maturities longer than 15 years, the grant element will be calculated based on ten-year averages. 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.

15. Large projects (as referred to in MEFP paragraph 31 and Table 2) financed by non-concessional foreign borrowing are defined as those projects involving total non-concessional foreign borrowing in excess of US$25 million.

16. The limit on short-term external debt applies on a continuous basis to the stock of short-term external debt owed or guaranteed by the central government or the Bank of Albania, with an original maturity of up to and including one year. It applies to debt as defined in paragraph 12 of this memorandum. Excluded from the limit are rescheduling operations (including the deferral of interest on commercial debt) and normal import-related credits. 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.

17. A continuous performance criterion applies to the nonaccumulation of new external payments arrears on external debt contracted or guaranteed by the central government or the Bank of Albania. External payment arrears consist of external debt service obligations (principal and interest) falling due after March 31, 2002 and that have not been paid at the time they are due, as specified in the contractual agreements. Excluded from the prohibition on the accumulation of new arrears are: (i) arrears arising from interest on the stock of arrears outstanding as of March 31, 2002; and (ii) external arrears that are subject to debt rescheduling agreements or negotiations.

F. Tax Revenues

18. Collection of total tax revenue by the Tax and Customs Departments and social insurance contributions will be monitored on the basis of quarterly indicative floors. These indicative floors will include all revenues collected by the GDT, GDC, and SSI (including revenues collected on behalf of local governments), but exclude revenues collected by local governments directly.

G. Monitoring and Reporting Requirements

19. Performance under the program will be monitored from information supplied monthly to the Fund by the Bank of Albania, the Ministry of Finance, the General Directorate of Taxation (GTD), the General Directorate of Customs (GDC), and the Ministry of Economy. This information will include the following, which will be supplied monthly (except where noted) and on a timely basis:

20. The Bank of Albania will supply to the Fund:

(i) The balance sheets of the Bank of Albania;

(ii) The consolidated accounts of the commercial banks;

(iii) The monetary survey;

(iv) Net domestic credit to the government;

(v) The net foreign assets of the Bank of Albania;

(vi) The foreign exchange cashflow of the Bank of Albania, including the level of

NIR;

(vii) Daily average exchange rates;

(viii) Trade flows;

(ix) Periodic updates of balance of payments estimates.

21. The Ministry of Finance will supply to the Fund:

(i) The summary fiscal table, including the overall budget deficit, on a cash basis;

(ii) Issuance of treasury bills by the MOF, including gross value and cash

received;

(iii) Privatization receipts;

(iv) Information on the contracting and guaranteeing of new debt;

(v) Information on the stock of short-, medium- and long-term debt;

(vi) Information on all overdue payments on short-, medium- and long-term debt

(with assistance from the Bank of Albania).

(vii) Information on the stock of VAT refunds claimed and refunds paid out every

month.

22. The General Directorate of Customs will supply to the Fund:

(i) Detailed monthly data on customs revenues collected; and

(ii) Quarterly reports on corrective measures taken to deal with problems

identified by the internal audit function.

23. The General Directorate of Taxation will supply to the Fund:

(i) Detailed monthly data on tax revenues collected.

24. The Ministry of Economy will either report quarterly to the Fund or publish quarterly:

(i) All instances of nonpayment on the agreed memorandums of understanding for the repayment of the stock of end-December 2001 inter-enterprise arrears.

(ii) A description of remedial actions undertaken by the ministry in the event of non-payment on the agreed MOUs for the repayment of the stock of end-December 2001 inter-enterprise arrear.