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

Dear Mr. Köhler:

1. In accordance with the provisions of the three-year arrangement (approved on September 26, 2001) under the Poverty Reduction and Growth Facility (PRGF), the government of Sierra Leone, in cooperation with staff of the IMF, has evaluated the implementation of the program to end-June 2003, and performance through September 2003. The attached memorandum of economic and financial policies (MEFP) highlights recent economic developments and performance during 2003, and sets out the government's macroeconomic objectives and policies and the structural reform agenda for 2004.

2. Economic activity remained robust in 2003, as agricultural and mining outputs continued to expand. In part, this reflects the progress the government of Sierra Leone has made in consolidating peace, including completing the disarmament, demobilization, and reintegration (DDR) program for ex-combatants, which has helped to bolster confidence. We expect the pace of economic expansion to continue strengthening in the medium term.

3. Performance under the PRGF-supported program in 2003 was mixed. The government met all quantitative performance criteria at end-June except on net bank credit to the central government and the domestic primary budget balance, reflecting mainly larger-than-programmed domestic development and interest outlays, and the clearance of domestic wage and public utility arrears that were not envisioned under the program. Furthermore, there were slippages in the implementation of structural measures envisaged under the program. The government of Sierra Leone took measures during the second half of 2003 to address the shortcomings and to bring performance broadly in line with the original program.

4. In view of the above, the government of Sierra Leone requests for waivers on the nonobservance of the end-June 2003 quantitative performance criteria relating to net domestic bank credit to the government and to the domestic primary budget balance, as well as on the nonobservance of the structural performance criteria related to the completion of payroll photo verification for all existing teachers with valid letters of appointment and the issuance of identification cards by the Ministry of Finance to all verified teachers. The government requests for the completion of the fourth review and the disbursement of the seventh loan under the PRGF arrangement in an amount equivalent to SDR 14 million (13.5 percent of quota). The government also requests an advance of additional interim HIPC assistance in an amount equivalent to SDR 14.75 million under the enhanced HIPC Initiative for the twelve-month period starting March 21, 2004. This additional interim assistance is needed since previous Fund interim assistance committed under the HIPC Initiative lapses on March 20, 2004, and Sierra Leone has obligations to the Fund falling due during the twelve month period mentioned above.

5. The government believes 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. Sierra Leone will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund's policies on such consultation. The government is continuing to address medium-term development issues and plans to complete the full poverty reduction strategy paper (PRSP) in the first half of 2004. The quantitative and structural performance criteria for the fifth review, and quarterly indicative targets through end-2004, are set out in Tables 3 and 4 of the MEFP.

6. Given the likely timing of the completion of the fourth review, the government would like to propose that the fifth review with the Fund be based on end-March 2004 quantitative performance criteria, and on structural performance criteria for end-February, mid-March and end-May 2004, and be conducted by no later than end-June 2004. The sixth and the final review of the program would be conducted by no later than end-December 2004, based on end-September quantitative performance criteria. In view of this, the government of Sierra Leone requests a six-month extension of the arrangement from the current expiration date of September 25, 2004.

7. The government authorizes the publication of this letter and the attached MEFP by the Fund, including the posting of such documents to the IMF website, subsequent to Executive Board approval.

Memorandum of Economic and Financial Policies
of the Government of Sierra Leone for 2004

I. Introduction

1. The peace and political reconciliation process that was initiated in 2002 continues to be consolidated, and refugees and internally displaced people are being resettled in their communities. The final phase of the disarmament, demobilization, and reintegration (DDR) program for ex-combatants has, by and large, been completed. The Special Court, set up under U.N. auspices in the country, has issued indictments against rebel, military, and militia leaders accused of war crimes. These developments, together with an improvement in the security situation in the country, are having a positive impact on economic activity, as well as on the environment in which the government's poverty reduction and growth policies are being implemented.

2. This memorandum of economic and financial policies (MEFP) complements the one issued in April 2003. It describes developments and performance during 2003 and spells out the government's macroeconomic objectives and policies and key elements of the budget for 2004.

II. Developments and Performance in 2003

3. Economic activity remained robust in 2003, reflecting the recovery of activity in the agricultural sector following the resettlement of the displaced population, the growth of diamond production, and the expansion of activities in the public and private sectors. Real output in 2003 is estimated to have grown by 6.5 percent, compared with 6.3 percent in 2002.

4. Inflation accelerated in 2003 from an annual average rate of -3 percent in 2002 to 4.3 percent in the year to September 2003, in part reflecting higher fuel prices, broad money growth, and the impact of the exchange rate depreciation against the U.S. dollar.

5. The overall deficit (including grants) was 5.3 percent of GDP for the first three quarters of 2003, thus remaining within the program target. In part, this outcome reflected better-than-anticipated domestic revenue performance. The government contained expenditure, in line with the shortfalls in foreign grants and borrowing. However, the shortfalls necessitated a partial accommodation through an increase in domestic financing.

6. Government domestic revenue for the period January–September 2003 amounted to Le 211.5 billion (11.3 percent of GDP), slightly exceeding the program target. However, external grant financing fell substantially short of program expectations, as delays occurred in the disbursement of project grants whereas program grants, including the Initiative for Heavily Indebted Poor Countries (HIPC Initiative) debt relief, were larger than programmed. Total expenditure and net lending amounted to 23.2 percent of GDP, well below the programmed level of 28.8 percent of GDP, reflecting slower-than-planned execution of development and HIPC Initiative-financed projects. Current spending, excluding DDR expenditure, was broadly in line with the programmed level. However, the government wage bill exceeded the program target in the third quarter by a small margin, reflecting payments of wage arrears.¹ Despite measures taken by the government to strengthen public accounting and budget execution, the level of "unaccounted items" in the government financial accounts rose to Le -14.9 billion (equivalent of 0.8 percent of GDP) in the first three quarters of 2003. The government has identified the causes for the discrepancy and is taking corrective measures to expedite the reconciliation of public accounts. While reconciling fiscal and monetary data, it emerged that some deposit accounts were incorrectly classified (by banks) as government accounts. The government has worked with the banks to resolve the data issue for 2003, for the purpose of program reporting. However, further work is still needed to reconcile the data for the previous program years. In this context, the government has requested technical assistance from the Fund to systematically remedy the problem.

7. Broad money increased by 16 percent in the period January-September 2003, compared with an increase of 7.2 percent under the program, owing to the higher-than-programmed growth of bank net domestic assets, including faster expansion in credit to the private sector. Reserve money also grew rapidly in this period, by 8.5 percent, exceeding the programmed level by 1 percent. Nominal interest rates were broadly stable in the first nine months of the year, but rising inflation substantially eroded interest rates adjusted for inflation, which fell from above 20 percent at end-2002 to about 3 percent in September 2003. Commercial bank nonperforming loans declined to about 11 percent at end- September 2003, in part due to the repayment of the government arrears to enterprises. The Bank of Sierra Leone (BSL) is strengthening its supervisory capacity, with technical assistance from the Fund, and remains vigilant in its efforts to supervise the banks.

8. The current account continued to be under pressure, mainly due to strong growth in imports and the higher cost of fuel. Exports also increased, in particular because of strong diamond exports, while agricultural exports, such as cocoa, also did well. The adoption of the Kimberley Process Certification Scheme at the beginning of 2003 by most diamond-exporting nations helped to reduce incentives for diamond smuggling. Gross external reserves declined by about US$8.3 million in the first half of the year to US$76 million, but recovered somewhat during the third quarter, in part because of a World Bank disbursement.² Official reserves at end-September were at about US$83 million. The real effective exchange rate depreciated by about 12 percent during the first nine months of 2003, mainly because of the nominal depreciation against the U.S. dollar.

9. The regular auctions of foreign exchange have been the main instrument of determining the exchange rate in Sierra Leone. However, in order to ensure a continuous flow of imported fuels into the country, the BSL had allowed oil companies to purchase foreign exchange at auction-determined exchange rates since early 2003, through a special window. The government closed the window in December. Foreign reserves are estimated to have declined to about 1.5 months of import cover by year's end, reflecting shortfalls in donor support. The spread between the official and parallel market exchange rates remained relatively stable within a range of 5-8 percent.

10. Six out of the eight quantitative performance criteria for end-June 2003 were met; the remaining two, pertaining to net domestic bank credit to the government and to the primary fiscal budget balance, were not met. The nonobservance of the ceiling on net bank credit to the government was caused mainly by the overruns on domestic development spending and interest outlays, and the clearance of domestic arrears. The end-June 2003 indicative target for poverty-related expenditure was not met. All indicative targets for end-March 2003 were met, except for ceiling on net credit to government, and the floors on the primary domestic budget balance and total domestic government revenue. All indicative targets for end-September 2003 under the program were observed, except for the floor on the primary domestic budget balance and the ceiling on the government wage bill. The government's domestic revenues exceeded the indicative target in September 2003.

11. The implementation of structural reforms in 2003 was slower than anticipated. The two structural performance criteria related to the completion of photo verification for all existing teachers with valid letters of appointment and the issuance of identification cards by the Ministry of Finance for all verified teachers were not observed at end-June 2003. The photo verification exercise was delayed because the needed equipment arrived only in August 2003. Subsequently, the verification exercise began and was completed by October 30, 2003 for all teachers in the payroll as of August 31, 2003, except for 102 teachers that could not be verified and have since been taken off the payroll. The government also started to issue identification cards for all verified teachers; a sample identification card was presented to the staff in September 2003. However, completion of the exercise was slower than anticipated because of logistical constraints. The government reached understandings with Fund staff that the issuance of identification cards for at least 80 percent of all verified teachers be completed by mid-December 2003, while, for the remaining 20 percent, the cards would be issued by mid-March 2004. The financial audit of the Ministry of Education—a structural benchmark for end-September—was launched in the second week of September and completed by end-October 2003.

12. With regard to other structural benchmarks for 2003, the photo verification system for civil servants and teachers in the Establishment Secretary's Office is not yet fully operational. Progress has been made with regard to the payment of teachers' salaries through the banking system for secondary schools and technical and vocational institutions; the government has implemented these payments by setting up individual school accounts rather than paying through personal accounts. This is in part because of the paucity of banking services in many rural areas and the need to minimize transaction costs for the teachers (intermediation fees charged by banks are high, given the low salary level for teachers). A tripartite committee on education comprising representatives of the Ministry of Finance, Ministry of Education, and the Teachers' Union has advised the Accountant General's Office on how to distribute payments in areas where no banking services are available. The Financial Secretary now approves all new teachers before they are added to the payroll. Salary payments of the 2,446 teachers who could not be verified during the KPMG audits of schools were suspended with effect from January 1, 2003. The affected teachers were recertified at end-May 2003, and 600 of them were reidentified and consequently reinstated on the payroll. Moreover, the amendments to the Income Tax Act, Sales Tax Act, and Customs Act to ensure consistency with the National Revenue Authority Act have yet to be completed, awaiting the provision of technical assistance.

13. The government took corrective measures to bring performance for the year as a whole closer to program objectives. In particular, an improved domestic revenue mobilization, together with efforts to contain total expenditures while protecting poverty-related outlays, helped in bringing fiscal performance within the program target. The government also accelerated the implementation of structural reforms. Against this background, most objectives for 2003, as outlined in the MEFP of April 2003, were attained. In the fiscal area, the overall deficit, including grants, would remain within the program target. The domestic primary deficit in 2003 is estimated at the level of 6½ percent of GDP, which is below the original program. However, broad money is expected to increase by 20 percent in 2003, exceeding the program level. As a result of the high import growth, the current account deficit (excluding official transfers) would widen from 26 percent of GDP in 2002 to 30 percent of GDP in 2003 (from 10 percent to 14 percent, including official transfers)

14. To ensure a more efficient utilization of public resources, a nationwide awareness program with respect to the 2003 budget allocations was conducted in May 2003 in all districts. In September 2003, the Ministry of Finance introduced a policy review process as the first stage in the medium-term expenditure framework (MTEF) cycle for 2004-06, comprising a review of macroeconomic and sectoral policies to ensure they are in line with national goals and policies, as well as an identification and estimation of the expenditure implications of agreed policies.

15. Within the MTEF, the government continues to monitor the effective and accountable use of public funds through the public expenditure tracking surveys (PETS). In collaboration with the World Bank and the U.K. Department for International Development (DfID), it carried out a review of the PETS process in March 2003. A pilot survey covering poverty-related lines of expenditure in the education sector was conducted in August 2003. A joint DfID/World Bank PETS support mission visited Sierra Leone in September 2003 and provided assistance in the analysis of data collected during the pilot PETS. The administration of survey questionnaires for the main survey, covering agriculture, health, and education for 2002 public expenditures, was carried out in early October 2003.

16. The government is fully convinced that an efficient and effective public sector is fundamental to sustainable economic growth and poverty reduction. For the past, the government has undertaken various initiatives to reform the civil service, but the reforms have not been effective due to the prolonged civil conflict; the civil service remains overstaffed and underpaid, resulting in poor motivation and an unsatisfactory quality of public services. A review of the civil service grading and pay structure is under way and will provide a basis for future reform, for which the government is seeking further technical and financial support from donors. It has also adopted a new civil service code, which constitutes the first comprehensive updating of the code in several decades and includes several measures designed to improve performance and reward merit. The code is being progressively introduced at all levels of the civil service. The Civil Service Training College, which has been closed for several decades, is also being reactivated.

17. The government has recently established an independent commission to undertake a comprehensive review of the public service and proffer recommendations for rapidly improving and strengthening the effectiveness and competence of the management levels of the civil service. The aim is to restructure those management levels to create a senior executive service.

18. The government recognizes that reforming the highly centralized public procurement system, which is based on an outdated 1963 legislation and procurement regulation, is necessary in order to improve efficiency in the utilization of public funds. Therefore, the government, with the support of key donors, including the African Development Bank (AfDB), DfID, United Nations Development Program (UNDP), and the World Bank, has committed itself to a fast-paced process of a comprehensive public procurement reform program involving institutional and legal changes, as well as changes in procedures and operations. A Procurement Reform Steering Committee (PRSC), chaired by the Vice President of the Republic of Sierra Leone and comprising representatives of the UNDP, World Bank, European Union, Ministry of Finance, and Office of the President has been established to direct and monitor the reform process. The UNDP Interagency Procurement Services Office (IAPSO) has been appointed as external management advisers on public procurement reforms. The formulation of a new procurement policy, including the drafting of a procurement law, is in progress. The government is considering outsourcing procurement in the interim period, until new procedures are in place.

19. The government initiated several actions during 2003 to jump-start the preparation of the full poverty reduction strategy paper (PRSP). A Core Technical Preparatory Committee was established and Interministerial and Steering Committees have been actively involved in the process. To deepen public awareness and ownership of the PRSP, a nationwide sensitization and awareness-raising program was conducted for the general public, cabinet, and senior government officials in August 2003. Significant progress is also being made on the ongoing Integrated Household Expenditure Survey. The draft outline of the PRSP has been developed and circulated for comments to all domestic stakeholders and donors. The PRSP document is to be finalized by mid-2004.

III. Objectives and Policies for 2004

20. While the government will continue to address the country's immediate postwar problems, including further consolidating peace and security and improving public sector service delivery, increased emphasis will be placed on maintaining macroeconomic stability, reducing poverty, and addressing long-term development issues. The PRSP will be used as the main vehicle to guide medium-term development efforts. Furthermore, the newly established National Recovery Committee will continue to facilitate the extension of civil authority throughout the country and to restore infrastructure for ensuring a smooth transition from recovery to development. The main objective for the government in 2004 will be to sustain a high level of real activity—a key element in the fight against poverty—and maintain low inflation. To succeed, monetary policy needs to remain appropriately tight and be supported by a prudent fiscal policy. The government will continue to address deficiencies in its operations and improve infrastructure to enhance the delivery of public services.

21. The program for 2004 projects real GDP to grow by 6.8 percent, supported mainly by the continued recovery of the agricultural sector and a further increase in reconstruction and investment activities. Average annual consumer price inflation is targeted to fall below 5 percent.

A. Fiscal Policy

22. Fiscal policy will continue to aim at supporting macroeconomic stability while enhancing revenue mobilization and increasing the efficiency and effectiveness of public sector operations, with a view to supporting poverty reduction efforts and accountability. The overall budget deficit (including grants) will narrow in 2004 to 7½ percent of GDP from the 9 percent projected in 2003, in part reflecting the increase in external sources available in 2004. The domestic primary deficit is projected at 6.5 percent of GDP, unchanged from 2003, while domestic financing will rise only modestly. Government domestic revenue is projected at 16 percent of GDP in 2004. Total expenditure and net lending is budgeted at about 36 percent of GDP, owing to the increased foreign-financed development expenditure; current expenditure is expected to fall by about 1 percentage point to 26 percent of GDP.

23. To attain the fiscal objectives, the government will ensure the timely implementation of reforms to improve tax administration, including through the strengthening of the National Revenue Authority (NRA). Further revenue measures include the collection of tax arrears (the level of which is now estimated at Le 11 billion) and the integration of the Diamond Evaluation Office into the NRA's Income Tax Department. In addition, the government will defer the implementation of the reductions in income and corporate tax rates, which were announced in the 2004 Budget Speech, until satisfactory revenue trends have been established for 2004. A study is planned for 2004 to examine the modalities for the introduction of a value-added tax. As the international community reduces its intervention in the securing of peace in Sierra Leone, the government will need to increasingly assume its responsibility in this area. The resulting pressures on the already stretched budgetary resources will require a rigorous prioritization of expenditures, in order to avoid expenditure cuts in critical areas (health, education, and social services).

24. The government will continue its specific efforts to improve expenditure controls in the education system, including through a strict management of the teachers' payroll. In this regard, the government will ensure that agreed ceilings are observed in terms of both the number of employed teachers and the related wage bill. The government will encourage senior public servants, including teachers with access to banking facilities, to open individual bank accounts to facilitate direct payment of salaries through the banking system. With the completion of the payroll photo verification and issuance of identification cards, the database of teachers will be continuously updated. The setting up of a payroll management unit in the Ministry of Education will reinforce these efforts. The database of civil servants and teachers of the Establishment Secretary's Office (ESO) will be updated monthly and used to update the payroll database of the Accountant General's Office. In the area of civil service reforms, the focus continues to be on strengthening the capacity and improving the efficiency of the public service. In this connection, the government will continue with the functional reviews of the remaining line ministries (under the review program) and implement reforms in the ministries in which reviews have been completed. The government will also put into effect new civil service rules and regulations by end-May 2004, which will benefit from World Bank technical assistance with respect to pay, grading, and job classification, expected to be completed by April 2004, and launch the project to convert the ESO into a modern personnel management office by end-June 2004.³

B. Monetary Policy and Financial Sector Reform

25. Monetary policy will continue to focus on controlling inflation. The BSL will pursue this objective mainly by managing the growth of its net domestic assets and would complement this, as needed, by maintaining a higher reserve requirement ratio and using interest rates more actively. Broad money is projected to rise by about 11 percent in 2004. The expected growth of bank net domestic assets reflects economic activity and the rise in the demand for money as confidence in the banking system continues to improve. Net bank credit to the government in 2004 as a whole will rise only modestly, in line with the goal of maintaining a sustainable level of domestic debt over the medium term.

26. The BSL has worked closely with the MFD on a program of reforms for 2003 and 2004 that aims to advance work in a number of areas. An active work program is being undertaken in banking supervision and monetary operations, areas in which considerable progress has been made in 2003. A successful transition to improved monetary operations and secondary market development is critical for the BSL's modernization program. In addition, substantial reform efforts are envisaged in respect of the payments system. The BSL will undertake a study to determine the best way forward toward unifying the reserve requirements on domestic and foreign currency bank deposits, with technical assistance from the Fund; at present, foreign currency deposits are excluded from the mandatory reserve requirement. Furthermore, the government will seek technical advice from the Fund on securitizing the remaining domestic verified payments arrears, which is now a structural benchmark for end-March 2004 under the program. The current level of these arrears is Le 19.3 billion. Of this amount, the government will make a cash payment to small creditors amounting to Le 1.9 billion and securitize the remainder, which is owed to one creditor.

27. The government is also committed to implementing the recommendations of the 2002 safeguards assessment by the Fund staff, with a view to further strengthening the BSL's internal controls. For the 2003 accounts, the current external auditors will be replaced with a combination of a local and an internationally reputable firm. The BSL also plans to complete the computerization of its bookkeeping system by June 2004. The government looks forward to the Fund's follow-up mission on safeguards assessment in the first half of 2004.

C. External Sector Policies

28. The current account deficit in 2004, excluding official transfers, is projected at 31 percent of GDP (at 16 percent, including transfers). In the short term, import demand will remain strong because of the recovery in economic activity and the large import needs related to reconstruction. On the export side, the increase mainly comes from diamond production, which is expected to benefit from an improved security situation and better access to mining areas; rutile exports will not begin before 2005.

29. Important progress was made in 2003 in laying a solid foundation for a revival of the mining sector, an effort that has benefited from significant assistance from the World Bank and DfID. A mining sector policy framework and an investment code are to be finalized in 2004. Attracting foreign investment into medium- and large-scale mining projects in Sierra Leone will in general require a careful balancing of the need for tax incentives with the medium-term objective of generating fiscal revenues from mineral wealth.

30. Sierra Leone is a resource-rich country, but it represents a challenging environment for mining companies to operate in, given its poor state of infrastructure, as well as the remaining security and governance concerns. To compensate for these drawbacks, and a worsened outlook for rutile prices, the government decided to grant Sierra Rutile tax concessions in order to restart the rutile-mining project. These concessions will reduce the overall tax burden (including payroll taxes) by about 50 percent and will total US$98 million over the life of the project. In return, the government will receive an equity stake in the mining project that accumulates over time and is projected to reach 30 percent when proven reserves are exhausted. The government plans to establish a unit for monitoring price and production developments. Following the conclusion of financing arrangement with Sierra Rutile, full-scale production could resume by 2005.

31. Other large-scale projects under negotiation are the resumption of bauxite and kimberlite mining by reputable international companies. Progress has also been made in fostering an enabling regulatory environment by conducting a mining sector study and by submitting the resulting policy recommendations for a mining sector regulatory framework to the cabinet. Work is under way with support from the DfID and the U.S. Agency for International Development (USAID) to conduct a diamond sector study. A stakeholder workshop was held in February 2003. The government will provide to the Fund a full account of tax concessions granted for mineral projects, including those that are under negotiation. It will also request for Fund technical assistance to help in broadly quantifying the fiscal impact of these concessions. The government will postpone any agreements on bauxite, kimberlite, petroleum, and other minerals, until a comprehensive mineral policy framework that could provide guidance on the appropriate level of tax incentives has been put in place. Fund staff will be consulted, in the context of the PRGF-supported program, on any commitments to be made in this area. The government will also develop a comprehensive medium-term budget framework, in time for the fifth review under the PRGF arrangement, that would incorporate expected revenue streams for all major mineral sectors.

32. The government will maintain a market-based exchange rate regime. A centerpiece of this policy was the introduction of the foreign exchange auction system in 2002. As for 2004, foreign exchange allocation to the auctions will be around US$1 million per week, which should provide room for a modest reserve buildup, equivalent to 2.2 months of import cover at end-2004.

33. In respect of debt relief, further progress has been made in completing negotiations with bilateral creditors. As of end-June 2003, total debt owed to official bilateral creditors amounted to about US$388 million, of which US$320 million was to Paris Club creditors. The government has signed debt-rescheduling accords on Naple terms with ten out of eleven Paris Club bilateral creditors and on Cologne terms with six bilateral creditors.⁴ Of the latter six, five creditors agreed to go beyond Cologne terms and provide 100 percent interim relief.⁵ The additional bilateral relief provided by these creditors has lowered debt service burden considerably by reducing debt-service payments post cut-off date and on rescheduled arrears that otherwise would have fallen due beginning in 2003. Of the official bilateral non-Paris Club creditors, the government has reached an agreement with the Saudi Fund for Development on the rescheduling of arrears, but on terms that fall short of what is required under the HIPC Initiative. The government also finalized an agreement with the OPEC Fund on arrears clearance using resources from the OPEC's Commodity Import Program, but the implied debt relief also falls short of what is expected under the HIPC Initiative. Validated commercial and military debt amounts to about US$100-80 million, of which about US$35 million (mostly related to military debt) is currently under litigation. The government has adopted a "best-effort" approach to engage these creditors, with a view to rescheduling the verified arrears over a long period. Success, however, has been limited so far.

34. To foster regional integration, the government plans to adjust its external tariffs gradually toward the agreed common external tariff (CET) of the Economic Community of West African States (ECOWAS). A study has been initiated to assess the fiscal impact of this change in the tariff regime, and a technical working group has been formed that brings experts together from all relevant ministries. Enabling legislation is being formulated and will be completed in time for the start of the implementation of the CET by January 2005.

D. Structural Reforms

35. Commitment by the government to combat corruption remains overarching. In this respect, steps are being taken to revamp the fight against corruption, shifting the focus from prevention to investigation and follow-up through prosecution. A review of the organization and activities of the Anti-Corruption Commission was completed in April 2003, with several recommendations made for strengthening the commission, including capacity building, strategic planning, staff rationalization, pay enhancement, and other improvements in the conditions of service. These recommendations were incorporated in the commission's new strategic plan, whose full implementation will take place during 2004. Apart from this, the 2002 annual report of the Anti-Corruption Commission indicated that prosecution was lagging far behind in alleged corruption cases. To this end, the government has sought external assistance from The Commonwealth for the provision of a special prosecutor, two judges, and a local legal support. The backlog of corruption cases awaiting trial at the Attorney General's Office is expected to decline, as the arrival of one of the judges from the United Kingdom (in September 2003) will expedite the trial of cases. On the investigative side, the relevant department of the commission will be further strengthened by the recruitment, with DfID assistance, of two principal investigators.

36. The National Commission for Privatization (NCP) has prepared a comprehensive plan for the implementation of the strategy for the divestiture of public enterprises. Twenty-four public enterprises have been slated for privatization. These enterprises have been classified by sector as well as by their current financial position, following initial diagnostic assessments by the NCP. Other actions already taken include advertisements for the registration of consultants to carry out diagnostic studies.

37. In March 2003, the government cleared all outstanding arrears to the National Power Authority (NPA), amounting to Le 4.6 billion. The government further paid out Le 2.4 billion in respect of current electricity bills. Following the clearance of the arrears, all ministries were expected to settle their bills directly with the NPA, which was advised to institute measures to secure payments, including disconnection. While this measure has increased significantly the payments of electricity bills, outstanding balances have been reported by the NPA. At end-September 2003, outstanding balances totaled Le 1.3 billion, of which past-due payments amounted to Le 0.5 billion, in part owing to delays by the ministries in paying bills and time lags related to processing payment vouchers. The buildup of balances was further influenced by the increase in electricity tariffs in June 2003, of 40 percent. Based on average monthly consumption of electricity by the ministries, the annual estimate is about Le 5 billion, which has been used in the 2004 budgeting. In 2004, the government is committed to settling the arrears to the NPA and to examining ways to prevent their reoccurrence. Certain institutional bills have been included in the government's obligations, including institutions receiving quarterly subventions from the government. To address this issue, the NPA has been authorized to adjust the bills and forward them to the identified institutions for payment. The concerned institutions have been informed accordingly.

38. The key structural measures to be implemented during September 2003-June 2004 are summarized in Table 4 of this attachment.

E. Prior Actions, Program Monitoring, and Reviews

39. The government has agreed that the following measures will constitute prior actions to be completed before Board consideration of the fourth review under the PRGF arrangement:

• payroll photo verification for all existing teachers who have valid letters of appointment, which was concluded by October 30, 2003;

  financial audit of the Ministry of Education, which was completed at end-October 2003; and

• issuance of identification cards by the Ministry of Finance to at least 80 percent of all verified teachers, completed by December 15, 2003.

Given the likely timing of the completion of the fourth review, the government of Sierra Leone requests a six-month extension of the arrangement from the current expiration date of September 25, 2004. The program will continue to be monitored based on quantitative and structural performance criteria and benchmarks indicated in Tables 3 and 4 of this attachment. There will be two reviews during 2004. The fifth review will be conducted by end-June 2004, based on end-March 2004 quantitative performance criteria, and on structural performance criteria for end-February, mid-March, and end-May 2004. The final review will be conducted by end-December 2004, based on end-September 2004 quantitative performance criteria.

Technical Memorandum of Understanding

1. This memorandum sets out the understandings between the Sierra Leonean authorities and the International Monetary Fund (IMF) regarding the definitions of the quantitative and structural performance criteria and benchmarks for the program supported by the Poverty Reduction and Growth Facility (PRGF) arrangement, as well as the related reporting requirements. The definitions have been revised to ensure that the memorandum continues to reflect the best understanding of the Sierra Leonean authorities and the Fund staff in monitoring the program. Unless otherwise specified, all quantitative performance criteria and benchmark will be evaluated in terms of cumulative flows from the beginning of the period, as specified in Tables 1 and 3 of the attached Memorandum of Economic and Financial Policies of the Government of Sierra Leone for July 1, 2003–December 31, 2004.

Quantitative Performance Criteria: Definitions and Data Sources

Gross Foreign Exchange Reserves of the Bank of Sierra Leone (BSL)

2. Definition. Unless otherwise noted here, gross foreign exchange reserves of the Bank of Sierra Leone (BSL) will be defined as reserve assets of the BSL. Reserve assets are defined in the IMF's Balance of Payments Manual (5^th ed.) and elaborated in the reserve template of the Fund's International Reserves and Foreign Currency Liquidity: Guidelines for a Data Template. They exclude, for example, foreign assets not readily available to, or controlled by, the monetary authorities.

3. Gross foreign exchange reserves consist of (a) monetary gold; (b) foreign currency in cash; (c) unencumbered foreign currency deposits at non-resident banks; (d) foreign securities and deposits; (e) SDR holdings and Sierra Leone's reserve position with the Fund; and (f) balances in the Bank of England account related to debt service to Paris Club creditors. Gross reserves will exclude nonconvertible currencies and pledged, swapped, or any encumbered reserves assets including but not limited to reserve assets used as collateral or guarantees for third party external liabilities.

4. Adjustment clauses. The floor on gross foreign exchange reserves will be adjusted (a) downward (or upward) by the amount in U.S. dollars of the shortfall/excess in programmed external budgetary assistance¹; (b) downward (upward) for any shortfall/excess in the U.S. dollar value of disbursements from the IMF under the PRGF arrangement; and (c) upward or downward for any increase in BSL short-term foreign currency-denominated debt (to residents and nonresidents), using the definition of short-term debt below.

5. For the purpose of this target, as well as of those for external debt and arrears, valuation will be in U.S. dollars, using the program exchange rates. For the 2004 program, the program exchange rates between the U.S. dollar and other non-leone currencies will be those prevailing at December 31, 2003.

6. Supporting material. Data on gross foreign exchange reserves, including its components, will be transmitted by the BSL to the Fund on a weekly basis within ten days of the end of each week.

Net Domestic Assets of the (BSL)

7. Definition. Net domestic assets (NDA) of the BSL are defined as the end-period (based on daily data) stocks, during the month of the test dates, of the reserve money less net foreign assets calculated at the program exchange rate of 2,600 leones per U.S. dollar. Reserve money includes currency in circulation and required reserves on leone deposits. Net foreign assets of the BSL are defined as gross foreign exchange reserves (defined above) minus foreign liabilities (defined below).

8. Foreign liabilities are defined as short-term (one year or less in original maturity) foreign currency-denominated liabilities of the BSL to nonresidents and the outstanding use of Fund credit.

9. Adjustment clauses. The ceiling on the NDA of the BSL will be adjusted upward by up to fifty percent of the amount of the shortfall in the external budgetary assistance at the test dates. The ceiling will be adjusted downward by the amount of the excess in the external budgetary assistance at the test dates.

10. Supporting material. Net domestic assets of the BSL will be transmitted to the Fund on a monthly basis within four weeks of the end of the month. This report will include foreign assets excluded from the definition of gross foreign exchange reserves in Section IIA above.

Net Domestic Bank Credit to Government (NCG)

11. Definition. NCG refers to the net banking system's claims on the central government and is defined as the following:

• the net position of the government with commercial banks, including: (a) treasury bills; (b) bonds issued by the Government of the Republic of Sierra Leone (GSL); (c) loans and advances; less (d) Central government deposits (defined to include account balances under the authority of controlling officers); plus
• BSL holdings of (a) GSL statutory bonds; (b) ordinary GSL bonds; (c) bonds in respect of loans to current and former parastatals; (d) treasury bills on the trading portfolio of BSL; (e) other government stock; (f) HIPC debt relief deposits; less (g) special non-interest-bearing government stocks to cover foreign exchange valuation losses.

12. Adjustment clauses. The ceiling on the increase in NCG will be adjusted upward by up to fifty percent of the amount of the shortfall in external budgetary assistance. The ceiling will be adjusted downward by the amount of the excess in external budgetary assistance. The leone value of the cumulative shortfall or excess in external budgetary assistance will be converted at the program exchange rate of 2,600 leone per U.S. dollar. The ceiling will also be adjusted downward (upward) by the net increase (decline) in the leone value of net issues of government securities to the nonbank private sector up to the ceiling set on net domestic bank credit to government for each test date.

13. Supporting material. The data source for the above will be the series "Claims on Government (Net)" submitted to Fund staff on a weekly basis and reconciled with the monthly BSL monetary survey to be submitted to the Fund within six weeks of the end of each month. These data will be reconciled with monthly reports on treasury bill transactions and the ways-and-means account, and with treasury bearer bond transactions to be submitted to the Fund staff by the Ministry of Finance, within six weeks of the end of each month.

Domestic Primary Balance of Central Government

14. Definition of Central government. Central government is defined for the purposes of this memorandum to comprise the central government and those special accounts that are classified as central government in the BSL statement of accounts. The National Social Security and Insurance Trust (NASSIT) and public enterprises are excluded from this definition of central government.

15. The floor on the domestic primary budget balance of the central government is defined as domestic revenue minus total expenditure and net lending, excluding interest payments, externally financed capital expenditure, and the externally financed DDR program.

16. Supporting material. The data will be submitted to Fund staff by the Budget Unit of the Ministry of Finance (MFIN) within six weeks of the end of each month.

Domestic Payment Arrears of Government

17. Domestic arrears of the government are defined as (a) any bill that has been received by a spending ministry from a supplier for goods and services delivered (and verified) and for which payment has not been made within 60 days; (b) wage and salary arrears that were due to be paid in a given month but remained unpaid on the fifteenth of the following month; and (c) interest or principal obligations that remain unpaid 30 days after the due date of payment. Any change in such arrears will be reported to the Fund within six weeks after the end of each month.

18. Supporting material. Data on government's domestic payment arrears referred to in this paragraph will be submitted to Fund staff by the Budget Unit of the MFIN within six weeks of the end of each quarter.

Domestic Revenue of Central Government

19. The target on total domestic government revenue is defined as total central government revenue, excluding external grants.

20. Supporting material. The data will be submitted to Fund staff by the Budget Unit of (MFIN) within six weeks of the end of each month.

Central Government Wage Bill

21. The ceiling on the government wage bill is defined as total expenditure outlays on wages, salaries, pensions, payments to NASSIT and cash allowances by the government.

22. Supporting material. The data will be submitted to Fund staff by the Budget Unit of the Ministry of Finance within six weeks of the end of each month.

Poverty-related Expenditures

23. Poverty-related expenditures refer to those expenditures in those areas identified in Table 2 of the Sierra Leone HIPC Decision Point Document (EBS/02/30; 2/19/02). These budgetary expenditures include but are not limited to those sub-components that are financed by drawdown from the HIPC Relief Account at the BSL.

External Payment Arrears

24. Definition. Official external payment arrears are defined as the stock of external overdue debt-service payments by the public sector. For the purposes of this Memorandum, the public sector will comprise the central government, all public enterprises and the BSL. The nonaccumulation of external arrears is a performance criterion during the program period. Excluded from this performance criterion are those debts subject to rescheduling arrangements. This performance criterion will apply on a continuous basis.

25. Supporting material. Data on arrears are compiled jointly by the MFIN and the BSL and will be reported to Fund staff by the Budget Director of the MFIN on a quarterly basis within six weeks of the end of each quarter.

Official Medium- and Long-Term Nonconcessional Loans

26. Definition. Those are defined as all forms of official debt contracted or guaranteed by the public sector.² This performance criterion applies not only to debt as defined in Annex 1of this Technical Memorandum of Understanding but also to commitments contracted or guaranteed for which value has not been received. This performance criterion will apply on a continuous basis. Excluded from this performance criterion are disbursements from the IMF and rescheduling arrangements. In this memorandum, the public sector consists of the central and regional governments and other public agencies, including the BSL.

27. Supporting material. Detailed data on all new concessional and non-concessional debt contracted or guaranteed will be provided to Fund staff by BSL/the Ministry of Finance on a quarterly basis within six weeks of the end of each quarter.

External Short-Term Debt Contracted or Guaranteed by the Public Sector

28. External short-term debt is defined as external debt with a maturity of less than one year contracted or guaranteed by the public sector. Debt is defined in Annex 1 of this Technical Memorandum of Understanding. For this purpose, short-term debt will exclude normal trade credit for imports. A performance criterion is no new external short-term debt during the program period. This performance criterion will apply on a continuous basis.

29. Supporting material. A comprehensive report on all new external debt with original maturity of less than one year owed or contracted by the public sector will be transmitted to Fund staff by the BSL on a quarterly basis within four weeks of the end of each quarter.

Subsidies to the NPA

30. The term "subsidy" refers to any financial government support (i.e., unrequited transfers) to the National Power Authority (NPA). It does not include the government's on-lending of external loans for capital expenditure of the enterprise. The subsidy is to be reduced by the amount of arrears accumulating in regard to the charges for government's electricity consumption. This performance criterion will apply on a continuous basis.

Program-Monitoring Committee

31. Definition. The Sierra Leonean authorities shall maintain a program-monitoring committee composed of senior officials from the Ministry of Finance, the Ministry of Economic Development and Planning; the Bank of Sierra Leone, and other relevant agencies. The committee shall be responsible for monitoring the performance of the program, recommending policy responses, informing the Fund regularly about the progress of the program, and transmitting the supporting materials necessary for the evaluation of performance criteria and benchmarks. The committee shall provide the Fund with a progress report on the program on a monthly basis within four weeks of the end of each month, using the latest available data.

Data Reporting to the Fund

Domestic Prices

32. Reporting standard. the monthly disaggregated consumer price index will be transmitted within four weeks of the end of each month.

Government Accounts Data

33. Reporting standard. A consolidated budget report of the central government comprising (a) the revenue data by each major item, including those collected by the National Revenue Authority, as well as privatization receipts to the budget; (b) details of the recurrent and capital expenditure of the central government; (c) details of budget financing (domestic and external), which will be transmitted on a monthly basis within six weeks of the end of each month; and (d) details on the government's outstanding arrears outstanding, including payments and other arrangements to discharge them (these data will be transmitted on a monthly basis within six weeks of the end of each quarter).

Monetary Sector Data

34. Reporting standard. The balance sheet of the central bank and the consolidated balance sheets of the commercial banks will be transmitted on a monthly basis within six weeks of the end of each month. A special report on transactions in the HIPC relief account at the BSL will be provided to the Fund on a monthly basis within six weeks of the end of each month. The results of the treasury bill auctions will be transmitted on a biweekly basis within five business days. The stocks of government securities, balances in the divestiture account, detailed information on interbank loans (terms, duration, and participating institutions), and interest rate developments will be transmitted on a monthly basis within two weeks of the end of each month.

External Sector Data

35. Reporting standard. The following standard will be adhered to: (a) the interbank market exchange rate, as the simple average of the daily-weighted average buying and selling rates, will be transmitted on a weekly basis within five business days of the end of the week; (b) the results of foreign exchange auctions (on a weekly or more frequent basis) will be transmitted on a weekly basis within five business days of the end of each week; and (c) the foreign exchange cashflow data will be transmitted on a quarterly basis within six weeks of the end of each quarter.

Implementation of the Revised Guidelines on Performance

Criteria with Respect to Foreign Debt

The term "debt" has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000 [which reads as follows: "(a) For the purpose of this guideline, 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. (b) Under the definition of debt set out in point 9(a) above, 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"]. (B) Excluded from this performance criterion are normal import-related credits, disbursements from the IMF, and those debts subject to rescheduling arrangements.