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

Tirana, June 24, 2004

Mr. Rodrigo de Rato
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. de Rato:

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 (PCs) under the program have been observed. We did not meet at end-March 2004 the PC requiring the implementation of the ASYCUDA system in the Durrës customs house and the initiation of an integrity audit of the system. However, we implemented the ASYCUDA system in the Durrës customs house in June 2004 as a prior action for completion of the fourth review. Regarding the integrity audit, we have postponed it at the recommendation of the EU Customs Assistance Mission in Albania (EU CAM-A). Given the progress in implementing the ASYCUDA system and the close supervision they provide, EU CAM-A now feels that the audit would be more useful if undertaken after the customs administration has gained more experience with the system. As this delay does not compromise program objectives, we request a waiver for the non-observance of this PC. As additional prior actions for the fourth review, we have allocated the revenues from the privatization of Savings Bank as detailed in the attached memorandum and started to pay wages of the central bank of Albania through the banking system. We request completion of the fourth 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 Annual Progress Reports of May 2003 and May 2004.

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

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,

/s/ Fatos Nano Prime Minister

/s/ Arben Malaj Minister of Finance

/s/ Shkëlqim Cani Governor, Bank of Albania

Supplementary Memorandum on Economic and Financial Policies (MEFP) for Albania

I. Background

1. This memorandum reviews the implementation of the PRGF-supported program, updates the macroeconomic framework for 2004-07, and lays out our policies for the period June 2004-March 2005. It is consistent with the November 2001 National Strategy for Socio-Economic Development (NSSED) and the May 2003 and May 2004 Progress Reports; and supplements the June 2002, January 2003, June 2003, and January 2004 MEFPs.

II. Performance under the Program

2. Following the crisis of 1997-1998, our government has achieved considerable success in creating the macroeconomic and structural conditions needed for the rapid modernization and development of our country. As an integral part of these policies we have adopted a poverty reduction strategy aiming to ensure that the benefits of economic growth are shared by the most vulnerable sectors of the population. The PRGF-supported program approved in June 2002 has been instrumental in advancing these policies.

• Since 1999, Albania's economic growth performance has been impressive by any standard. During this period, output growth averaged 7 percent, underpinned by a stable macroeconomic environment. We have reduced inflation, which is now within the 2-4 percent target range of the Bank of Albania (BoA). Private investment, although still low relative to our growth needs, has increased as a proportion of GDP. The current account deficit has narrowed since 2002 supported by a rapid increase in exports. Reserve cover rose substantially each year, while confidence in the lek firmed up, reflected in its steady appreciation.
  
  
• We achieved significant fiscal consolidation, which played a key role in maintaining macroeconomic stability. The overall fiscal deficit is now about 5 percentage points of GDP lower than it was in 1999, most of it accounted for by higher public savings. Although still below our targets, the tax revenue-to-GDP ratio has increased by 2 percentage points of GDP in 1999-2003, while our tax system has undergone significant modernization. Through lower deficits and the use of privatization receipts for debt amortization, we have reduced the public debt-to-GDP ratio from 76 percent at end-1998 to an expected 55 percent at end-2004.
  
  
• We carried out measures to improve the transparency, accountability, and efficiency of our tax (GDT) and customs (GDC) administrations, and plan to intensify efforts in this area as much remains to be done. These reforms included implementation of ASYCUDA within the Tirana and Durrës custom houses; extension of civil servant status or its equivalent to the staff of the GDT and GDC; hiring of additional qualified employees in the GDT and GDC; greater public dissemination of internal tax procedures and regulations; greater taxpayer protection through a strengthened appeal process and the publication of appeals proceedings; and more use of information technology. We assigned taxpayer identification numbers to all businesses but suffered delays in completing the process for individuals. The first phase of the transfer of social security contributions collection to the GDT (large and VAT taxpayers) has been implemented and subsequent steps toward the full transfer are under way.
  
  
• We have regularized public sector inter-enterprise arrears and set up a system to prevent the emergence of new ones. Building on the progress achieved in 2003, memorandums of understanding rescheduling or clearing all arrears incurred up to December 2001 between public enterprises and government agencies have been signed. Provision for the full payment of these obligations, and of arrears incurred after 2001, are now appropriated in the budget on a current basis. To prevent the re-emergence of arrears, compliance with the MOUs is being closely monitored by a dedicated task force within the Ministry of the Economy, as well as by an inter-ministerial working group established by the Prime Minister. We have adopted a plan to regularize the repayment of the outstanding stock of VAT refund arrears over 2004-05.
  
  
• We are implementing reforms in the budget process aimed at enhancing transparency, improving parliamentary oversight, and allowing better targeting of expenditure toward meeting our poverty-reduction and growth objectives.
  
  
• We are modernizing our financial sector and fostering banking intermediation. We are improving our accounting standards, supervisory capacity, and enabling legislation, including on the insurance sector. The recent sale of Savings Bank places our entire banking system under private management, and we expect this to galvanize competition, improve service delivery, and increase the level of lending to the private sector. In addition, our completion of a real-time gross settlement system (AIPS) early this year, the establishment of a complementary intraday collateralized credit facility, and the forthcoming inauguration of a bulk settlement system, will establish a safe and efficient market infrastructure. With assistance from the IMF, EU, US Treasury and other donors, we are developing the technical expertise and legal framework to combat more successfully money laundering and terrorism financing. We have requested an FSAP to assess progress to date in these areas, and to help in the design of future reforms.
  
  
• On the external front, we have regularized half of our external arrears, and expect to finalize agreement on the remainder within the program period. We have concluded regional free trade agreements, and are negotiating a Stabilization and Association Agreement with the EU.
  
  
• We also carried out a number of measures to improve the investment climate and governance. These included adopting and implementing the Action Plan for reducing the administrative barriers to investment identified by FIAS; implementing the Law on Asset Declaration of public officials; improving our system for combating money laundering; and enforcing compliance with existing conflict of interest legislation.

III. Policies and Measures for July 2004-June 2005

A. Overall Strategy

3. As we enter the final year of our PRGF arrangement, our strategy for reducing poverty and effecting rapid economic development remains broadly unchanged. Monetary and fiscal policies will continue to promote macroeconomic stability and growth. Essential to the successful transition to a rules-based market economy, we will pursue institution-strengthening and governance-enhancing policies and intensify our anti-corruption efforts. As the business climate improves, we expect growth to become more export driven, and increasingly sustained by rising levels of foreign and domestic investment, rather than aid flows, which are expected to decline in both volume and degree of concessionality over the longer term. At the same time, we are committed to reducing poverty; pursuing greater efficiency and equity in the mobilization and use of resources; and improving essential services such as health care, education, and social protection. Our strategy will require broad-based support and we will deepen our policy dialogue with all stakeholders.

B. Macroeconomic Outlook

4. We expect the medium-term outlook to remain favorable. Growth is forecast to stay close to its trend of 6 percent during 2004-07, while monetary policy and further fiscal consolidation will hold inflation within its 2-4 percent target band. The volume growth of merchandise goods exports is expected to remain strong in 2004, at about 17 percent, while import volume growth will be close to 14 percent. Over the medium term, as continued improvements in the business climate take hold, growth will be increasingly driven by rising foreign and domestic export-generating investment. Ongoing reforms to enhance the efficiency of tax administration, combined with a concerted effort to reduce the size of the informal economy, will increase tax revenue as a share of GDP and permit an expansion of priority expenditure within a framework of further fiscal consolidation. As this consolidation takes place, and the business sector takes on an increasing role, public and private consumption will decline as a share of GDP. We will gradually reduce our reliance on foreign savings, although we expect the narrowing of the current account deficit to be accompanied by a rising share of foreign trade in GDP, reflecting our increasing integration into the world economy.

C. Fiscal Policy

5. We are taking the actions needed to adjust our 2004 fiscal program in order to meet our domestic financing targets. This became necessary after our revised projections indicated that 2004 revenue would fall short of its budgeted level by more than the ¼ percent of GDP reserve established for this contingency, and that external disbursements would be under-realized by 0.1 percent of GDP. We intend to continue improving our revenue forecasting capabilities as well as the practice of basing such forecasts on objective and prudent assumptions. For 2004, we see the need to take adjustment measures of 0.7 percent of GDP. In the short-term, this will mainly take the form of expenditure reductions, but we have introduced revenue-enhancing measures in parliament and plan to introduce further tax policy legislation later in the year having a full impact in 2005.

• We allocated the proceeds from the sale of Savings Bank (1.6 percent of GDP). We will use half to retire domestic debt and the rest will be spent on well-designed capital projects—already identified in consultation with the World Bank—in priority areas consistent with the NSSED.
  
  
• We will reduce expenditure in 2004 by about 0.6 percent of GDP. We will not release Lek 1 billion of spending from the Reserve Fund, as agreed during the third program review; and will reduce expenditure by about Lek 3.6 billion from administrative and non-priority operations and maintenance, other current spending, and selected capital projects in non-priority areas. As a precaution against unforeseen events, we will maintain a Contingency Fund of Lek 2 billion. We will release the latter funds at end-September 2004, only if the cumulative revenue (excluding project grants) is not less than Lek 134 billion, the net credit to government quantitative performance target is met, and prospects through the end of the year are consistent with the fiscal program.
  
  
• We are introducing revenue-enhancing tax-policy measures equivalent to about 0.1 percent of GDP already in 2004. We have increased rural social security contributions, and raised the minimum quality grade of imported diesel—which will result in higher indirect tax collection as well as environmental benefits. We intend to increase excise rates on cigarettes before the summer parliamentary recess, generating 0.1 percent of GDP on an annual basis. We have also increased casino registration fees. Conditional on the evolution of international energy prices, we are considering to include customs duties in the base for excise duties on diesel in the 2005 budget.
  

With these adjustments, we now expect an overall deficit in 2004 of 5.8 percent of GDP in 2004. Domestic borrowing is set at 1.9 percent of GDP—equivalent to the original budget value adjusted for the saving of half of the privatization receipts; and consistent with our previous program targets.

6. We are committed to support the integrity of our monetary framework and the independence of the central bank. Our process of fiscal consolidation will support monetary policy. As required by the central bank law, and in application of international best practice, we will issue treasury bills to the BoA by the amount required to cover the accumulated net reserve valuation losses (stemming from the appreciation of the lek) as reflected in its final balance sheet as of end-2003—currently estimated at Lek 6.4 billion. We will also reduce the maximum permissible level of direct lending from the BoA to the government—now set at 5 percent of the previous year's budget revenue—by at least ½ percent each year.

7. The budgets of 2005 and subsequent years will implement a strategy of further fiscal consolidation aiming at offsetting the likely decrease in external assistance and placing the public finances on a sustainable path. In 2005, net domestic credit to the government will be set at 2½ percent of GDP—a decline of ¼ percentage point of GDP with respect to the underlying 2004 level computed before the savings from privatization proceeds. Tax measures will include price indexation of specific excises and fees—in addition to structural measures recommended by FAD aimed at further harmonizing the VAT, profit tax, personal income tax, and social insurance contributions with international best practices. Revenue will be further augmented by the full year effect of the measures enacted in 2004. We will complete the transfer of social security collection to GDT, and reform the employee compensation schemes in the GDT and GDC reinforcing performance-based incentives. Over the medium term, domestic borrowing will decline further, while total public debt is projected to decline from 55 percent of GDP in 2004 to 53 percent of GDP by 2007—before considering the additional decline that will result from the planned but still unbudgeted large privatizations. Based on conservative estimates of concessional foreign financing, this implies that the overall deficit will fall to 4½ percent of GDP in 2005, and further to 3¾ percent of GDP by 2007. Underpinning this medium-term profile, we will continue reforms to expand the tax net, improve the efficiency of expenditure, and raise the level of skill and professionalism of public servants.

8. We will work toward instilling greater transparency, accountability, and parliamentary control into the budget process. We have secured technical assistance from the U.K. DFID to improve our overall budget process. As agreed at the time of the third review, we will lower the maximum allowable transfer between appropriations in the 2005 budget to 5 percent. We will introduce greater detail into the appropriations of the 2005 fiscal package, particularly on current expenditure, and seek to establish a greater degree of prioritization of capital spending. We will improve compliance with procurement procedures, and ensure that all budgetary institutions develop and comply with internal rules to limit administrative and non-priority spending. We will also work toward establishing more detailed and timely reporting of fiscal developments to Parliament and to the general public.

D. Monetary and Financial Sector Policies

9. Monetary policy will continue to aim at keeping inflation within the 2-4 percent target band of the BoA, while maintaining an adequate level of reserves. The repo rate, supported by open market operations, will remain our main policy instrument to ensure adherence to our monetary program. Over the remainder of the program period, we expect money demand to remain broadly stable as share of GDP. From its current low base, private sector credit will grow rapidly, while the share of currency in broad money will continue to decline, reflecting rising confidence in the banking system and increased intermediation in the economy. We aim at maintaining foreign reserve coverage equivalent at least four months of imports, with the programmed 2004 increase in foreign reserves reflecting privatization receipts. We will maintain a flexible exchange rate regime with intervention used mainly for smoothing short-term shocks unrelated to fundamentals.

10. The BoA will press ahead with additional structural reforms aimed at improving banking sector intermediation and financial services provision.

• In close consultation with commercial banks, government institutions, and the private sector, the BoA developed an action plan in June 2004 for increasing the use of the banking system in the regular conduct of business. As a prior action for completion of the fourth review, and as a pilot to be extended to all public employees within one year, the BoA began paying the salaries of all its professional staff through the banking system. This practice will be extended to all remaining BoA employees and to a further 3,500 public employees by end-September 2004 (PC). By end-2004, at least 10,000 public employees will be paid through the banking system (PC; end-December 2004). In the context of discussions for the fifth review, we will consider the possibility of increasing this target in light of experience gained.
  
  
• The BoA will develop and make operational a bulk clearing system in collaboration with the World Bank, aiming at full operation in the first half of 2005. We will also take appropriate steps to support the AIPS, and ensure the proper functioning of the Intraday Collateralized Credit Facility. We will initiate the legal reforms necessary for the evidential value of electronic signatures, including preparing draft legislation in collaboration with the IMF and World Bank. Also with IMF and World Bank assistance, we will prepare draft legislation updating the Banking and the Accounting Laws.

11. The BoA will develop an action plan for implementing MFD's technical assistance recommendations in the areas of banking supervision, stress testing, inflation targeting, and accounting. With regard to banking supervision, these actions will be fully consistent with the completion of the World Bank-supported Supervisory Development Project. We will continue to strengthen our analytical capacity within BoA in preparation for an eventual adoption of inflation targeting. We will fully cooperate with the IMF safeguards policy and provide updated documents and data as necessary; and will also avail ourselves of technical assistance from the MFD resident advisor.

E. Structural Policy

12. Governance and institution-building reforms remain critical for developing a rules-based business climate and attract increasing levels of investment. Although we have achieved progress over time, with support from the World Bank, EU, OSCE, and UNDP, we believe that further progress is needed, particularly in those areas that hamper investment and capital flows, such as civil service and judiciary reform, and fighting crime and corruption.

13. We are committed to reducing administrative barriers to investment and business creation, which are still high, including relative to neighboring countries. Implementation of our Action Plan developed in conjunction with FIAS is on track (SB; ongoing). By end-December 2004, we will complete our first comprehensive self-assessment of the reform process, and will prepare an updated set of measures. In this regard we have already initiated a second round of the Administrative and Regulatory Cost Survey and will focus on removing remaining industrial licenses, streamlining required inspections, improving the appeals system, and developing outcome-based indicators.

14. Building on the newly gained privatization momentum, we will prepare Albtelekom for its prompt privatization. We will fully divest our interest in INSIG, two oil-sector companies, and remaining minority positions in two commercial banks over the next 18 months. As was the case with the Savings Bank, we will use half the proceeds of the sale of Albtelekom, remaining stake in INSIG, and other future large privatizations to retire public debt; and the remaining revenue to finance priority investments.

15. We will improve the quality and professionalism of the public sector. Reform in this area has moved slowly, particularly with respect to training and our ability to attract and retain highly-skilled staff. We aim to relate more closely public service pay and bonuses with productivity and performance. In this context, we will implement Instruction No. 2 of Law No. 8549 assigning specialists to higher wage categories in time for inclusion in the 2005 fiscal package. We are also engaged in discussions with IMF staff as to whether our recently-introduced policy of indexing wages to changes in the CPI contradicts this aim. While we continue to see some merit in this policy, we have agreed to fully review the issue at the time of the fifth review.

16. We have taken steps to improve the coordination of donor assistance through the creation of a secretariat under Office of the Prime Minister. It will monitor and coordinate relations with donors in four main categories of assistance, and mirror counterpart structures set up by the donor community under the lead of the EU, World Bank, OSCE, and UNDP. We are also considering introducing a law to formalize the preparation, prioritization, execution, and evaluation of foreign-financed investments and create the necessary institutions to improve coordination with the donor community.

17. Actions to rationalize the utilities sector will continue in consultation with the World Bank. To cushion the social impact of the attendant tariff increases, we plan to implement a subsidy to low income electricity consumers as of September 2004 (SB).

18. Within the constraints imposed by the sustainability of the public finances, we are progressing in the area of property recognition, restitution and compensation, necessary for solidifying the property rights needed for private sector development. The selected form of compensation will be transparent and rules-based. The forms of compensation will exclude any tax credit or exemption and give priority to issuing equity in state-owned property, rather than generating budgetary obligations.

F. External Policy

19. We remain committed to a liberal trade regime and will continue to work toward concluding a Stabilization and Association Agreement with the EU and achieving an Albania-EU free trade area. During 2003 and the first quarter of 2004 six new Free Trade Agreements were ratified by Parliament, including a free trade agreement with Kosovo. Three of them, however, have not yet taken effect as they are awaiting ratification by the trade partners.

20. We are continuing to restructure our outstanding stock of external arrears, and aim to completing the process with official creditors by the end of the program period. Agreements with Hungary and private creditors from FYR Macedonia were ratified by Parliament in March 2004. We have also made substantial progress with the Czech Republic, the Slovak Republic, and Poland on the terms of rescheduling and hope to complete these negotiations in 2004.

21. We will continue to improve the management of non-concessional foreign-financed investment projects and their integration with the corresponding sectoral strategies outlined in the National Strategy for Socio-Economic Development (NSSED) and the Medium-Term Budget Program (MTBP). We aim for further progress on establishing and following transparent, competitive procedures for negotiating and selecting favorable supply and lending agreements, pursuant to international practices and procedures and Albanian legislation. In this context, large-scale projects will be subject to international open tenders and will be executed only if independent feasibility studies by international standards are prepared (SB; ongoing). We will inform the IMF on a quarterly basis on the list and status of projects being considered for non-concessional financing (SB; ongoing). Quantitative PCs for September 2004 and March 2005, and indicative targets for June and December 2004 have been set as ceilings on the contracting or guaranteeing of public and publicly-guaranteed non-concessional borrowing.

G. Data Issues

22. We are working toward improving the quality and coverage of economic statistics, which continue to hamper monitoring of developments and economic policy making. In cooperation with our technical assistance providers, including through two major projects funded by the IMF (Italian subaccount) and the EU, we are improving 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 prepare a plan to accelerate the regular preparation and improve the timeliness of the national accounts to be discussed during the fifth review. Additionally, we will employ surveys and other tools to improve our statistics on foreign direct investment through comprehensive coverage of at least the largest enterprises, and will ensure the provision of adequate resources to INSTAT.

H. Program Monitoring

23. The sixth disbursement under the PRGF-supported program will be based on the end-September 2004 quantitative PCs and end-December 2004 indicative targets (Table 1 and the TMU); the end-September and end-December 2004 structural conditionality (Table 2); and completion of the fifth review and the financing assurances review. The seventh disbursement under the PRGF-supported program will be based on the end-March 2005 quantitative PCs; and completion of the sixth review and the financing assurances 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 provide a new progress report on the NSSED by April 2005, taking into account the recommendations of the joint staff assessment of the 2004 progress report.

Table 2. Albania: Performance Criteria and Structural Benchmarks under the PRGF Arrangement

Use the free Adobe Acrobat Reader to view Table 1 (10 Kb PDF file)

Technical Memorandum of Understanding

This memorandum defines the quantitative benchmarks and performance criteria established in the Memorandum of Economic and Financial Policies (MEFP) for end-June 2004-end-March 2005.

A. Net Domestic Credit to the Central Government

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

2. Net domestic credit to the central government (NCG) is defined as gross domestic credit in lek and in foreign currency extended to the central government (as defined above) by the banking system, savings and loan institutions (SLIs), and other domestic lenders;¹ less the sum of central government financial assets held in the banking system and in the SLIs.

3. The following definitions apply to gross domestic credit to the central government:

(i) Gross domestic credit in lek and in foreign currency extended to the central government includes: (a) securities (including treasury bills and bonds) issued by the central government and held by the Bank of Albania (BoA), deposit money banks (DMBs), SLIs, and other domestic lenders; (b) loans and advances extended to the central government by BoA, DMBs, SLIs, and other domestic lenders; and (c) negative balances in government deposits with BoA, DMBs and SLIs.

(ii) Gross domestic credit in lek and in foreign currency extended to the central government excludes (a) the onlending of foreign project loans to all parts of central government; and (b) advances on profit transfers by the BoA. The value of the stock of gross domestic credit to government will also exclude the claims held by the units of central government as defined above (in particular, the SSI and the HII).

(iii) The stock of gross domestic credit extended to the central government and held by the BoA and DMBs in the form of treasury bills will be valued at issue price. The stock of gross domestic credit extended to the central government and held by the BoA in the form of other securities and direct loans to government will be valued excluding accrued interest. The stock of gross domestic credit extended to the central government and held by the DMBs in the form of fixed and variable income securities will be valued at face value. The stock of all gross domestic credit extended to the central government and held by SLIs and other domestic lenders will be valued at face value.²

4. The following definitions apply to central government financial assets held in the banking system and in the SLIs:

(i) Central government financial assets held at the Bank of Albania include: (a) transferable deposits in domestic and foreign currency; (b) lek deposits held in BoA for projects; and (c) standard gold deposits of the central government. For the purposes of program monitoring, standard gold deposits will be valued at the program price of gold (SDR 280.6 per ounce).³

(ii) Central government financial assets held at the Bank of Albania exclude: (a) foreign currency deposits related to foreign financed projects; and (b) deposits serving as the counterpart for non-standard gold and other precious metals owned by the central government.

(iii) Central government financial assets held at the DMBs include: (a) all deposits of central government in domestic and foreign currency; (b) all loans extended by central government to commercial banks; and (c) payable amounts owed by the DMB to central government.

(iv) Central government financial assets held at the SLIs include all deposits of central government held at the SLIs.

5. For the purposes of program monitoring, central government financial assets in foreign currency will be converted from Lek to SDRs at the end-of period Lek/SDR exchange rate prevailing on the test date; and then converted to Lek at the end-December 2003 Lek/SDR exchange rate of Lek158.1/SDR.

6. According to the above definitions, as of end-December 2003 the level of gross domestic credit to the central government was Lek 277.9 billion; the level of central government financial assets held in the banking system and in the SLIs (excluding deposits of the SII and HII) was Lek 7.5 billion; and the level of deposits in the banking system and the SLIs of the SSI and HII was Lek 2.2 billion. The level of net domestic credit to central government was Lek 268.1 billion. The breakdown of the categories defined above is given in Attachment Table 1.

7. The limits on the change in net domestic credit to the government will be cumulative from end-December 2003.

B. Net Domestic Assets

8. The stock of 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 at the BoA-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 2003. Under this definition, the level of the NDA was Lek 72 billion as of end-December 2003. The NDA limits will be cumulative changes from end-December 2003 and will be monitored from the accounts of the Bank of Albania.

C. Net International Reserves

9. 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-à-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.⁴ Reserve assets and reserve liabilities will both be expressed in U.S. dollars.

10. During this program, for monitoring purposes, the exchange rates of the SDR and non-dollar currencies will be kept at their end-December 2003 levels and holdings of monetary gold will be valued at SDR 280.6 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

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

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

12. 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 loan financing (excluding IMF financing, project and commodity loans, and macro-financial assistance from the EU) will amount, on a cumulative basis, from January 1, 2004, to:

In cases where total foreign loan financing exceeds this projection, the ceilings on NCG to the government and NDA of the Bank of Albania will be adjusted downward, and the floor on NIR will be adjusted upward by the amount of the excess.⁵

13. 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

14. 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.

15. 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 sub-limits 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 14 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.

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 14 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 non-accumulation 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.

18. Large projects (as referred to in MEFP paragraph 21 and Table 2) financed by nonconcessional foreign borrowing are defined as those projects involving total nonconcessional foreign borrowing in excess of US$25 million.

F. Tax Revenues

19. 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

20. 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 (GDT), 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:

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 and (separately) the SLIs;
(iii) The monetary survey;
(iv) Net domestic credit to the government (in the form outlined in Appendix Table 1);
(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.

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.

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.

The General Directorate of Taxation will supply to the Fund:

(i) Detailed monthly data on tax revenues collected.

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 arrears.