Tirana, May 25, 2000

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

Dear Mr. Köhler:

1.  The authorities of the Republic of Albania have continued to pursue policies that are being supported by the second annual arrangement under the Poverty Reduction and Growth Facility (PRGF). Inflation has been effectively reduced to zero while GDP increased by about 7¼ percent in 1999 and is expected to grow at a similar rate in 2000. Structural reforms and progress in improving tax administration have also continued. As a result of measures taken since the midyear review, revenue performance has improved significantly and smuggling has been curtailed. All end-March 2000 quantitative performance criteria were met, and we are confident that the three prior actions agreed with the staff will be implemented by June 7, 2000. We, therefore, request that the end-period review under the second annual arrangement be completed.

2.  Based on the Interim Poverty Reduction Strategy Paper (I-PRSP), which has been separately submitted to the IMF and the World Bank, the attached Supplementary Memorandum on Economic and Financial Policies describes our economic program and key policy measures supporting our request for the third annual PRGF arrangement for the program period April 2000–March 2001. In particular, we have reached understandings with the Fund staff on further measures to improve tax administration and strengthen revenue performance. We are also making every effort to ensure a satisfactory conclusion of the sale of the National Commercial Bank, proceed with the privatization of the Savings Bank, and complete six important privatization projects in the enterprise sector.

3. The Government and the Bank of Albania believe that the policies outlined in the attached memorandum are adequate to achieve the targets of the program, but in consultation with the IMF, will take any further measures that may become necessary for this purpose during the program period. In addition, the authorities will provide the IMF with such information as the IMF may request in connection with the implementation of the policies and objectives of the program.

Sincerely yours,

Supplementary Memorandum on Economic and Financial Policies of the Government of the Republic of Albania for the Completion of the Second Review Under the Second Annual PRGF Arrangement and for the Third Annual PRGF Arrangement

I.  Introduction

1.  Macroeconomic performance over the past year has been favorable. During 1999, GDP increased by 7¼ percent, owing in part to the Kosovo-related demand shock. Growth exceeded 10 percent in the construction and service sectors and remained robust in the industrial and agricultural sectors. More recent evidence indicates that strong growth is continuing in 2000. The annual inflation rate fell sharply early in 1999 and has remained negative ever since, reflecting the substantial strengthening of the Lek in 1998 and the first half of 1999, as well as the effects of the diversion of aid-related imports into domestic markets. The current account deficit widened by about 2 percentage points in 1999, to 8 percent of GDP, owing to higher imports resulting from the Kosovo crisis. However, the balance of payments position remained strong, reflecting foreign assistance and private inflows, and external reserves increased by about US$100 million in 1999.

2.  The fiscal outcome was broadly as envisaged under the program in 1999, although tax revenues were below the target. The overall general government budget deficit in 1999 widened by 1 percentage point relative to 1998, to about 11.3 percent of GDP reflecting Kosovo-related expenditures of about 1½ percent of GDP. Domestic financing of the budget deficit, excluding privatization proceeds, at 5.2 percent of GDP was about 1¼ percentage points lower than in 1998. Total tax revenue in 1999 fell short of the target, with particular weaknesses in custom duties and VAT only partially offset by good performance in collecting excises and income taxes. The tax revenue shortfall was compensated by higher-than-expected profit transfers from the Bank of Albania (BoA) and lower expenditures resulting from delays in project implementation. Weakness in revenue collection in the last quarter of 1999 was responsible for the fact that net domestic financing of the budget at end-December 1999 was by about Lek 1.6 billion (0.3 percent of GDP) above the indicative target under the revised program.

3.  Revenue performance has improved significantly in the first quarter of 2000, largely as a result of measures taken following the midyear review. Since November, we have implemented a number of important measures, including the continuous updating of reference prices for imports, strengthening the anti-smuggling units at customs, improving controls on goods in transit, introducing regular internal audits and taking disciplinary actions where necessary. Moreover, we have introduced secured VAT invoices, taken measures to enforce the registration of wholesale traders, and established cross-checking of VAT returns with customs data. These measures have already resulted in a reduction in smuggling and a significant improvement in revenue performance in the first quarter of 2000, when the tax collections were higher by a remarkable 40 percent than in the same—admittedly weak—period of 1999. As a result, cumulative revenues since January 1999 came out only around Lek 1 billion below the end-March 2000 target, compared to some Lek 2.5 billion at end-1999. The new law on fiscal procedures, in force since March 2000, provides a sound legal basis for the relationship between taxpayers and the authorities.

4.  Monetary policy was loosened gradually during 1999, but private sector credit growth remained slow. In early 1999, monetary policy was constrained by concerns caused by the Kosovo crisis. Subsequently, minimum deposit interest rates, currently the main monetary policy instrument, were gradually reduced, from 15.0–15.5 percent in May 1999, to 7.0–8.0 percent in March 2000. Expansion in private sector credit was much below the projections throughout 1999 and early 2000, despite the efforts to improve the legal framework and accounting practices in the enterprise sector. Moreover, credit growth was affected by the unforeseen delay in the privatization of the National Commercial Bank (NCB). Strong growth in broad money continued at about 20 percent in the year to February, reflecting the rapid output growth and increased confidence in the banking system. The performance criterion on the Bank of Albania's net domestic assets for end-March 2000 was met.

5.  We have made substantial progress in structural reforms over the past year despite the adverse effects of the Kosovo crisis. In the enterprise sector, we have liquidated, privatized, or transferred to local authorities about 520 small and medium-size enterprises; prepared the transfer of several mines and a production facility in the chromium sector, and completed the transfer of the copper mines to foreign investors; and made substantial progress in preparing Albania Mobile Communications (AMC) for privatization. In the financial sector, we approved the law for the privatization of the Savings Bank (SB) and are close to completing the sale of the NCB; and we are preparing the implementation of the law on collateralized transactions to make the legal framework for private sector credit more effective. In the area of public administration, we approved the civil service law and removed about 5,000 positions from the budget sector payroll in 1999 and a further 3,000 so far in 2000, lowering the size to about 127,000 employees. We have also made progress in liquidating the assets of the pyramid schemes and have started distributing the proceeds to former investors.

II.  The Government's Macroeconomic and Structural Policies

A.  Objectives

6.  Our main objectives are to maintain the economy on a rapid growth path, reduce the development gap relative to the European average, improve overall living standards, and reduce the poverty of those most in need. We are aware that to achieve these objectives we have to preserve macroeconomic stability, deepen the process of structural reforms, improve governance, and strengthen efforts to attract foreign investment. We will therefore continue to conduct our policies in the framework of a PRGF arrangement for the period April 1998-March 2001, for which the IMF provides financial support. The remainder of this memorandum details the macroeconomic and structural policies for the period ahead. We believe that these policies will be sufficient to achieve the program objectives, but will take additional measures and seek new understandings with the IMF should the program diverge from its specified targets.

7.  To better focus our policies toward poverty alleviation, we are preparing a comprehensive poverty reduction strategy, which will be incorporated in a Poverty Reduction Strategy Paper (PRSP) to be approved by the government by mid-2001. This strategy will build upon our achievements in this area, particularly in relation to social assistance, education, land reform, and rural development—made in the context of policies developed with assistance from the World Bank and other international organizations and bilateral donors— and will also cover health, infrastructure, and other sectors. To strengthen the effectiveness and public support of our poverty-alleviating policies, we will organize a broad consultative process that will include representatives of civil society groups, local communities, poor people themselves, and foreign donors. The steps for arriving at a full-fledged PRSP are described in the interim PRSP, approved by the government in April, which also includes a three-year macroeconomic framework and a policy matrix as agreed with the Fund and World Bank staffs.

8.  Macroeconomic policies for 2000 and 2001 will aim at supporting rapid GDP growth as well as maintaining low inflation and a prudent level of official reserves. To achieve the growth target of about 8 percent, we intend to proceed rapidly with structural reforms, improve governance, and complete the privatization process as described below. While some macroeconomic indicators currently suggest a downside risk for the targeted growth rate in 2000, structural reforms, in particular the completion of several important privatization projects, are expected to induce a pick-up in private investment and growth. Regarding inflation, after the unwinding of special factors in 1999, we expect that it will increase to about 2–4 percent, a level consistent with relative price adjustments characteristic of a rapidly growing economy. External reserves are expected to remain at 4½ months of imports. Specific targets for 2000 and 2001 are tabulated below.

B.  Fiscal Policy

9.  We will continue the policy of gradual fiscal consolidation. The 2000 budget envisages an overall budget deficit of 9¼ percent of GDP, down from about 11¼ percent in 1999. It projects the domestically financed deficit to decline from 5.2 percent of GDP in 1999 to 4¼ percent in 2000 excluding privatization receipts, which will cover another ½ percent of GDP. In line with the ceilings envisaged under the program (see Table 1), foreign borrowing will be limited largely to resources provided on concessional or close to concessional terms by international organizations and bilateral donors. Assuming that the overall macroeconomic framework will remain as projected, further fiscal consolidation is foreseen for the 2001 budget, with the domestic deficit declining by close to another percentage point of GDP. We expect that the overall deficit will not be larger than 8½ percent of GDP. We agree that the passage by parliament of a satisfactory 2001 budget will be a condition for completing the midyear review of the program under the third annual PRGF arrangement.

10.  Despite the recent improvements in tax performance, we are aware that further progress is required in both customs and tax administration to meet the ambitious revenue target for 2000. The budget incorporates an increase in the tax revenue to GDP ratio by about 2¼ percentage points of GDP without increasing tax rates. Achieving the revenue target is central to the implementation of the budget and the collections by the Tax and Customs Directorates will therefore be monitored by quarterly indicative floors.

11.  In the area of customs administration, we will implement the following measures:

• Starting May 1, the internal audit unit has re-commenced the production of bi-weekly reports on the results of internal audit inspections, and the Director General will take disciplinary actions and submit monthly reports to the Minister of Finance. (While the internal audit unit has continued inspections to control the implementation of the valuation principles, the production of reports was discontinued owing to the need for further training of the staff.) Submission of the reports for May constitutes a prior action for the completion of the second review of the second annual arrangement, while their subsequent regular submission will be a continuous structural benchmark. Moreover, since end-March we have filled 10 vacant positions in the regional internal audit units, and are currently organizing training for all 16 officials in the internal audit units, with the assistance of the EU Customs Assistance Mission (CAM-Albania). We will also prepare precise terms of reference for internal auditing.

• To address the substantial problems in the implementation of import valuation principles, we are introducing a training program for 60 officials in the valuation units at the local, regional, and central level, which will be completed by end-May (prior action), when we will also prepare a manual on valuation. The central valuation unit will also start collecting statistics on the implementation of the various valuation methods.

• In cooperation with CAM-Albania, we are also in the process of reviewing the structure of the post-clearance control units, and implementing measures to strengthen their personnel structure and improve the cooperation with customs administrations of neighboring countries. We expect that these measures will result in a significant increase in the number of post-clearance cases successfully processed.

• We are implementing the new system of remuneration of customs officials as agreed with CAM. By end-May, we will reward some 50 customs officials for seizure of smuggled goods. We have also issued instructions so that the special bonus system can be implemented in June. Moreover, by end-May, we will issue instructions on a new annual appraisal system for all customs officials.

• We will continue with the accelerated collection of customs debt, where we have recently achieved good results by raising monthly collections from Lek 10–15 million on average in 1999, to Lek 100 million in January and February.

• With a view to curbing the abuse of the special customs regime licenses for inward processing, the Customs Directorate will audit the users of these licenses by end-2000 and apply fines or withdraw licenses in accordance with the customs code. Quarterly targets for completing these reviews will be structural benchmarks under the third annual arrangement. By end-June we will have completed the audit of 16 companies, by end-September of 151 companies and by end-December the control of all 396 enterprises that currently benefit from these licenses. The completion of the control of the ten largest licensed companies by end-May is a prior action for the completion of the second review of the second annual arrangement.

12.  With regard to the Tax Directorate, we are implementing the following measures:

• We plan to increase the number of registered small business taxpayers from the current number of 25,000 to 30,000 by the end of 2000.

• In the area of internal revenue collection, the Tax Directorate will collect all new tax obligations of the state-owned electricity company, KESH, and the oil refinery. The Directorate will also strengthen efforts to collect tax arrears from other taxpayers.

• With support from the World Bank and the IMF's Legal Department, we are conducting a special training program to educate selected tax officials, who will in turn function as trainers in the Tax Department.

• With a view to improving the accountability of government institutions and building the trust of taxpayers, the Tax Directorate will strengthen its efforts to reimburse VAT in a timely manner. Moreover, we will amend the VAT law by December 2000 so as to introduce a binding time schedule for all reimbursements. We also intend to request technical assistance from the Fiscal Affairs Department of the Fund on further improvements in the VAT collection.

• In a similar vein, the Tax Directorate will strictly follow the rules prescribed under the profit tax law on the advance payments of profit tax and will promptly reimburse taxpayers after the submission of final returns.

13.  We are proceeding with efforts to widen participation in the social security system. To improve the administration of social security benefits and reduce opportunities for evasion, we have started to introduce social security numbers for all individuals and expect to finalize the process by early 2001. Moreover, amendments to the social security law, which we expect to submit to parliament by end-October, will include measures to strengthen the authority of inspectors in collecting contributions (structural benchmark).

14.  The expenditure program under the 2000 budget reflects the government's priorities for investment and social expenditures. Total expenditure is set to decline from 32.6 percent of GDP in 1999 to 31.8 percent of GDP in 2000, reflecting the fading of Kosovo-related spending and lower interest outlays. Investment expenditures, on the other hand, are projected to rise from 5.7 percent of GDP in 1999 to 6.4 percent of GDP in 2000, equivalent to a 20 percent increase in real terms. Expenditures on health and education are set to rise by 9 percent and 8 percent in real terms, respectively. The budget allows for an 8 percent nominal increase in budgetary wages on July 1, while pensions are set to rise by 10 percent. At the same time budgetary employment has been cut by 3,000 staff by end-March and will be cut by another 3,000 by end-October, in part by moving budgetary institutions into the non-budgetary sector and by cutting unfilled vacancies, while maintaining the quality of public services.

15.  As the sustainability of the recent improvement in revenue collection remains to be proven, we will execute the 2000 budget with prudence. We have prepared a monthly expenditure program designed to provide some cushion for any unexpected revenue shortfall, which will be reviewed at the time of the next staff visit in July. In particular, we are committed to limit spending from the reserve and contingency fund in the budget to exceptional cases.

16.  We are putting in place a medium-term expenditure framework (MTEF) with assistance from the World Bank, which will be used in the formulation of expenditure priorities in the 2001 budget. Sector working groups in line ministries are currently preparing expenditure plans based on sector strategies for health, education, transport, public works, and social protection that will explicitly include poverty reduction goals. We intend to complete the first MTEF for 2001–03 by July 2000. We will continue with the public expenditure tracking exercise now that the donors have resolved outstanding legal issues about financing. Assuming that we are successful in strengthening tax administration and improving the efficiency of collection, for the 2001 budget we will review the profit tax law and explore—with assistance from the IFC—the possibility of introducing an investment tax credit to strengthen incentives for private investment.

17.  We are also taking additional steps to improve the accuracy and transparency of fiscal management. Past reports regarding foreign-financed project expenditure in the budget have proved unreliable. The government will improve the coordination through monthly updates on the disbursements of foreign-project-related loans and grants submitted by the Ministry of Economic Cooperation and Trade to the Ministry of Finance. As of the 2001 budget, preparation of the investment budget will be integrated into the regular budgeting procedures in the Ministry of Finance. Moreover, to enhance transparency, we have taken measures to improve cash management and prevent unintended negative balances in our account with the SB. The government is also taking all the necessary steps to introduce a GFS-based economic expenditure classification by end-June, in time for the 2001 budget preparations.

C.  Monetary and Exchange Rate Policies

18.  The BoA will continue to conduct monetary policy with a view to ensuring low inflation consistent with the overall macroeconomic objectives. Minimum deposit interest rates for the state-owned banks will continue to be set based primarily on an assessment of price developments, the demand for lek deposits, and conditions in the foreign exchange market. In deciding on interest rates in the period ahead, the BoA will not feel constrained by moderate variations in the exchange rate and will continue to conduct its monetary operations in the context of a flexible exchange rate regime. Intervention in the foreign exchange market will be limited to smoothing short-term exchange rate fluctuations while ensuring that NIR targets are met.

19.  The monetary program is consistent with the domestic financing of the budget deficit of 4¼ percent of GDP in 2000 and private sector credit growth equivalent to 1 percent of GDP. The sharp decline in velocity experienced in 1999, associated with a stock adjustment in the demand for bank deposits since 1998, is projected to slow down during 2000, with lek money growing at about 12 percent, compared with 20 percent in 1999, and the broad money aggregate, which includes foreign currency deposits, at 12 percent, compared with 22 percent in 1999. In our view, rapid growth in deposits, including foreign currency deposits (some 19 percent of M3) in 1999, reflects increased confidence in domestic banks. End-September 2000 and end-March 2001 ceilings and floors for, respectively, NDA and NIR of the BoA, and ceilings on net credit to the government are performance criteria for the midyear and end-year reviews of the third annual PRGF arrangement.

20.  The BoA is phasing out instruments of direct monetary control. In consultation with Fund staff, the Bank is considering removal of floors on deposit interest rates in state-owned banks. Moreover, to increase BoA's capability to conduct open market operations, the government will convert its nonmarketable obligations to the BoA into marketable securities by September (structural benchmark). The BoA is also exploring ways to follow activities in the informal financial sector on a more systematic basis through interviews and surveys. For prudential reasons, the BoA will continue to enforce lending limits on banks with a high proportion of nonperforming loans.

D.  Structural Policies

21.   We remain committed to reforming the financial sector through a combined agenda of privatization and improvements in the institutional framework. Regarding the NCB, we will negotiate bona fide about the put options recently requested by the investors (Kent Bank, the EBRD, and the IFC). We will also stand ready to fully recapitalize the NCB as soon as the privatization contract has been signed. Regarding the SB, we will continue with the preparations for privatization by end-2000, with assistance from the World Bank. For this purpose, we have appointed an advisor from the U.S. Treasury to the management board of the bank. With assistance from the World Bank, we will appoint a chief operating officer and a chief accounting officer by June 2000. The tender for the privatization advisor will be announced in June (structural benchmark), the contract with the advisor will be signed by end-September (structural performance criterion for the first review of the third annual arrangement), the tender for privatization will be announced in November (structural performance criterion for the first review of the third annual arrangement), and the negotiations with selected potential buyers will start in December (structural benchmark). Regarding other measures for the SB, we will renew the governance contract with the management by end-May. We will also take other steps to improve accounting in the bank, including by hiring foreign advisors with the assistance of the World Bank. We will recapitalize the bank by end-2000, and the BoA will prepare a draft of the law on deposit insurance by July 2000. Regarding the state-owned insurance company INSIG, we will prepare it for privatization with assistance from the World Bank by mid 2001. We will also take further steps in opening up the insurance market and review the legislative framework for the insurance industry.

22.   We will implement measures to increase the participation of private banks and other investors in the T-bill and lek deposit markets, and to facilitate the development of financial markets. The BoA has completed the implementation of the measures agreed with MAE staff in July 1999 for strengthening the functioning of primary auctions, improving the marketability of T-bills, and fostering the development of a secondary market for government securities. The BoA will continue to take steps to enhance the development of the T-bill market, including strengthening transparency of the T-bill auctions, exploring measures to improve the refinancing facilities based on T-bills, and introducing remuneration of mandatory reserves to reduce bank intermediation costs. Moreover, the Ministry of Finance and the BoA will explore possibilities for improving access of nonbank investors to the T-bill market, including sales through tax and post-offices. As recommended by MAE, we will introduce a campaign for better informing households and other potential investors about possibilities for investing in T-bills. We are preparing for the introduction of a deposit insurance scheme, the timing of which will be decided in consultation with Fund staff. To improve the payments system, the BoA is working on implementing a real-time gross settlement system.

23.  To improve the legal framework for private sector credit, we will take all the measures required for the implementation of the law on secured transactions, approve new laws on bankruptcy and offices for execution of court decisions, and make the credit information bureau fully operational. Specifically, we will provide the required space and resources for the computerization of the registry for collateralized property, which will be fully functional as of July 1, 2000 (structural benchmark). Moreover, all tax administration claims will be immediately registered with the office to avoid subsequent interference with private claims. To strengthen the execution of court decisions in civil cases, we will submit to parliament a law on offices for execution of court decisions in civil cases by end-2000 (structural benchmark). Training of the judiciary in commercial issues by the consulting company will continue over the next 12 months. We are also preparing a new bankruptcy law that will be approved in parliament by December 2000 (structural benchmark) and will ensure that it is fully consistent with the law on secured transactions. We are currently working closely with a bilateral donor to transfer the credit information bureau to private hands and make it fully operational by end-2000 (structural benchmark). To facilitate private sector credit growth, the BoA is also embarking on an information campaign to improve communication between private banks and the business community.

24.   In the area of enterprise privatization, we will strive to complete several projects which, in addition to the immediate benefits of privatization, will have an important signal value for attracting the interest of foreign investors in our country. In the enterprise sector, we intend to complete the privatization of Albania Mobile Communications (AMC) and five mid-size enterprises (the brewery, winery, dairy, pharmaceutical factory, and the cement factory). Regarding the AMC, we have approved a detailed time schedule, according to which the contract should be closed by June 2000. Regarding the other projects, we have completed all preparatory work with the assistance of the privatization advisor, approved all appropriate decrees, and initiated the resolution of related issues of land ownership and claims by employees. The completion of the privatization of AMC and two of the five SMEs by end-September will be a structural performance criterion for completion of the first review of the third-year arrangement. We will also implement in collaboration with the World Bank an action plan to take two school-book publishing and distribution houses to the point of sale.

25.   In the mining and oil sectors, we will continue with the privatization of the remaining largest enterprises. We intend to either sell or lease the Burrel smelter and the Bulqize mine by end-2000 with assistance from the privatization advisor (structural benchmark). In the oil sector, the Ministry of Public Economy will prepare by end-June an action plan for selling and liquidating parts of the loss-making oil drilling and service company, Servcom (structural benchmark). By July we will split this company into smaller units, which will be privatized by end-2000 (structural benchmark). With regard to the refinery ARMO, we will proceed with the preparations for its privatization as soon as the contract with IMI, the investment advisor for strategic projects, becomes operative again.

26.   We will proceed with the preparation for the privatization of Albtelecom, which has been delayed owing to difficulties in disbursing the grant for financing the services of the privatization advisor for strategic projects. Until this issue has been resolved and to avoid further delays, we have requested a complete auditing of the 1999 Albtelecom financial statements by an internationally recognized auditing firm, to be completed by June 2000 (structural benchmark). Moreover, in cooperation with the EBRD, we are exploring the possibility of reviewing the tariff structure, implementing appropriate changes, and introducing a new system of accounting by December 2000 (structural benchmark). We are aware that delays in privatization will likely reduce the value of the company, and will therefore strive to complete the process by mid-2001.

27.   We will proceed with our efforts to create an institutional and legislative environment more conducive to foreign direct investment (FDI) and remove obstacles to the conduct of efficient private economic activities in Albania. In cooperation with the World Bank we will establish by September 2000 a mediation center that will offer an alternative means of dispute resolution in commercial cases and are currently preparing the necessary amendments to the civil and civil procedures code. In order to make procedures for the approval of FDI projects more transparent and accessible to foreign investors, we will explore in cooperation with donors the establishment of a one-stop investment shop, which would provide the services associated with the promotion and facilitation of FDI within the same agency. In addition, we will create an industrial park in Durres as a free zone to provide foreign investors with a strategic location and adequate legal, administrative, and logistical support for their activities. To further the consolidation of private land holdings, the government will continue with the registration of land at a rate of 150 cadastral zones per quarter (structural benchmark).

28.   To improve quality and coverage of economic statistics, we are committed to strengthening INSTAT, the central statistical agency. We will continue to implement the work program for each of the major statistical areas that was prepared in collaboration with the multisector statistics mission from the IMF in early 1999. In the 2001 budget, we will allocate another 20 permanent staff positions to INSTAT to strengthen its capacities. To establish national accounts, INSTAT will proceed with implementing the recommendations of the resident technical advisor submitted in December 1999, envisaging first results for internal use by end-2000 and the publication of national accounts by mid-2001. A central office will be set up within INSTAT for the compilation and analysis of enterprise balance sheet data and three additional staff positions will be created by end-June. To improve the short-term monitoring of real economic developments, INSTAT has started to compile indices on construction costs as well as on turnover in retail trade, which will be published quarterly, starting in the second quarter of 2000. Within the second half of the year it will also start to publish a unit value index and a production volume index covering private sector activity, the latter on a monthly basis. INSTAT will cooperate with the upcoming PPI mission from the IMF with a view to beginning publication of a quarterly PPI by end-July, and will request a similar mission that will assist in reviewing CPI weights with the aim of publishing a revised index in early 2001. The government is further committed to drafting a new law on statistics with assistance from the European Union in line with the requirements of the fundamental principles of statistics as set out by the UN. The law will provide a secure legal basis for the activities of INSTAT and will, in particular, prescribe penalties for companies not complying with the reporting requirements.

E.  External Sector Policies and Program Financing

29.  There are no immediate concerns about balance of payments sustainability. With investment and reconstruction needs remaining large, the current account deficit is expected to remain broadly unchanged, at 8¼ percent of GDP in 2000. In the medium term, the current account deficit is projected to decline as exports rise in response to foreign investment, which is expected to benefit from improvements in public order and economic reforms. Moreover, private remittances are expected to grow steadily. The current account deficit in 2000 is fully financed on the basis of projected inflows of foreign direct investment and official bilateral and multilateral support.¹ Small financing gaps are projected to open up in 2001 and to continue in the medium term. The external financing of the program will be reassessed at the time of the mid-year review.

30.   We will continue to regularize our relations with external creditors. The government has reconciled estimates of arrears to Russia and Italy subject to the July 1998 Paris Club Agreement and will aim to conclude the respective bilateral agreements within the new deadline to be agreed upon with the Paris Club. The External Debt Committee has prepared a timetable and has formed working groups for reconciliation and rescheduling of debt in arrears. It will continue to meet monthly to monitor progress toward regularizing relations with external official and commercial creditors so that the remaining restrictions subject to IMF approval under Article VIII, Section 2(a), in the form of outstanding debit balances under inoperative bilateral payments agreements can be removed. By end-2000, the government aims to reconcile and reschedule debt in arrears to Russia, Italy, Turkey, Hungary, Czech Republic, Slovak Republic, Romania, Greece, Bulgaria and Poland. The government will seek at least comparable treatment from non-Paris Club creditors with outstanding similar claims on Albania.

31.   The open and liberal trade policy will continue. Since 1998 the top tariff rate has been cut in two steps from 30 percent to 18 percent, and a further cut to 15 percent is foreseen for 2001, reducing the unweighted average tariff rate to about 13 percent from about 15 percent at the start of reforms. The government intends to maintain the current simple and transparent structure of three non-zero tariff rates and not introduce any new quantitative restrictions on exports or imports. Import licensing of fuels aimed at supporting the application of domestic technical standards will remain automatic and consistent with the principle of national treatment.

32.   We will seek to improve aid absorption and monitoring. We have provided adequate funds in the 2000 budget for reimbursement of VAT and customs duties and for land expropriation. To improve transparency and to speed up project implementation, time-bound planning will be introduced for land expropriation and the respective timetables will be announced to the public upon the start of projects. With technical assistance from UNCTAD, the government will make an external debt and aid database fully operational by end-June 2000 and will ensure timely and accurate reporting of external debt, including commitments by state-owned enterprises.

III.  Program Monitoring

33.  During the third annual ESAF arrangement, the program will be monitored based on quantitative performance criteria and indicative targets for end-September 2000 and end-March 2001 (the latter to be set at the time of the first review), and indicative targets for end-June and end-December 2000, and end-March 2001, set on a cumulative basis from end-December 1999 (Table 1), and structural performance criteria and benchmarks (Table 2). The government will conduct with the IMF a mid-year review of the program no later than end-January 2001, and an end-year review to be completed no later than end-June 2001. The quantitative targets include: (i) a floor on the net international reserves (NIR) of the BoA; (ii) a ceiling on the net domestic assets (NDA) of the BoA; (iii) a ceiling on domestic bank and non-bank credit to the general government (NCG), including extra-budgetary funds; (iv) a ceiling on the contracting or guaranteeing by the public sector of new non-concessional medium- and long-term external debt in the maturity range of 1–15 years, with a subceiling on the contracting or guaranteeing of new non-concessional external debt in the maturity range of 1–5 years; and (v) a ceiling on the stock of outstanding short-term external debt, with the exception of normal import-related credits. Details on the monitoring of indicative targets and quantitative performance criteria are set in the Technical Memorandum of Understanding (Attachment I to this Memorandum). The NIR floor will be adjusted upward and the NDA and net credit to government (NCG) ceilings downward for any excess in balance of payments or external budget financing above program projections and/or any shortfall of the Kosovo-related budget expenditure from program projections. The NIR floor will be adjusted downward and the NDA and NCG ceilings upward to the extent that there is any shortfall in balance of payments or budget financing from program projections and/or any excess of the Kosovo-related budget expenditure from program projections, with the proviso that the downward adjustment to the NIR floor shall not exceed US$50 million and the upward adjustment to the NDA and NCG ceilings shall not exceed the lek equivalent of US$50 million. The ceilings on NCG will also be adjusted downward for any excess in privatization receipts over the program levels (Table 1). A substantial deviation of the NIR from program projections or larger variability of the exchange rate will trigger consultations with the IMF staff. Collection of tax revenue will be monitored on the basis of quarterly indicative floors on total and customs revenues. During the program period, Albania will not impose or intensify exchange restrictions on current transactions or import restrictions for balance of payments reasons, and will not accumulate new external payments arrears, except for obligations for which a rescheduling is expected.

Albania
Technical Memorandum of Understanding

This memorandum defines the quantitative benchmarks and performance criteria established in the Memorandum of Economic and Financial Policies for 2000–01 (MEFP).

A.  Net Domestic Credit to the Central Government

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

2.  Net domestic credit to the government (NCG) is defined as the sum of credits in lek and in foreign currency, except for onlending of foreign project loans to all parts of the central government as defined above, including Treasury bills and bonds, less the sum of central government deposits with the banking system (but excluding foreign currency deposits related to foreign financed projects), and the deposits of the SSI and the HII. Credits comprise bank loans and advances to the government, holdings of government securities, due but unpaid interest, and negative balances in government accounts with banks. The component of the domestic credit to government in the form of securities will be calculated based on data on their outstanding stock valued at issue price, with the adjustment for the amount held by the units of central government as defined above (in particular, the SSI and the HII). Data on other components of credit to government will be reported by the BoA based on monetary statistics.

3.  Those components of net credit to the government denominated in foreign currencies are to be valued at the relevant market rates at the time of issue or redemption. Sales of Treasury bills will be counted excluding the discount. Reported repayments of Treasury bills and other government securities will not include interest payments, either as coupon interest or the discount.

4.  According to the above definition, the level of net domestic credit to government was Lek 154.65 billion on December 1, 1999. On the liabilities side this was composed of (i) total outstanding T-bills at issue price in the amount of Lek 145.5 billion, of which lek 35.6 was held by the Bank of Albania, lek 104.3 by commercial banks, and lek 5.6 by nonbank institutions; (ii) other government lek securities, loans, and other claims on government in the amount of Lek 22.8 billion. On the asset side it was composed of (i) central government deposits (excluding social security funds) in the amount of Lek 5.8 billion; and (ii) social security and health insurance deposits and T-bill holdings in the amount of Lek 7.9 billion. The Bank of Albania will inform the staff about any revisions in this data based on final monetary accounts for 1999.

5.  The limits on the change in net domestic credit to the government will be cumulative from the end of December 1999.

B.  Net Domestic Assets

6.  The net domestic assets (NDA) of the Bank of Albania are defined as the difference between reserve money—defined as the sum of currency issue (less lek notes and coins held by the Bank of Albania) and commercial bank reserves held by the Bank of Albania—less the net international reserves of the Bank of Albania (Section C), with all foreign currency assets and liabilities valued in local currency for program monitoring purposes at an exchange rate of 135.2 leks per U.S. dollar. Under this definition, the level of the NDA was Lek 72.5 billion as of December 1, 1999. The NDA limits will be cumulative changes from end-December 1999 and will be monitored from the accounts of the Bank of Albania.

C.  Net International Reserves

7.  Net international reserves (NIR) of the Bank of Albania consist of gross international reserves, which are readily available (i.e. liquid and marketable and free of any pledges or encumberments), controlled by the Bank of Albania and held for the purpose of meeting balance of payments financing needs, intervention in exchange markets, and other purposes, net of foreign liabilities, both expressed in U.S. dollars, and net of foreign currency reserves of commercial banks held at the Bank of Albania. Foreign liabilities shall be defined as liabilities to nonresidents contracted by the Bank of Albania, irrespective of their maturity. They include IMF purchases and disbursements; and all arrears on principal or interest payments to commercial banks, suppliers, or official export credit agencies

8.  During this program, for monitoring purposes, the exchange rates of the SDR and non-dollar currencies will be kept at their end-December 1999 levels and holdings of monetary gold will be valued at SDR 35 per ounce. Excluded from gross international reserves are holdings of nonconvertible currencies, claims on nonresident financial institutions denominated in nonconvertible currencies, and other claims, which are not readily available. Excessive exchange rate variability—that would require consultation with the staff—is defined as a change in the average euro rate in either direction of over 5 percent over a period of one month, or 7½ percent over a period of three months.

D.  Adjusters

9.  The NCG, NDA, and NIR targets are defined based on the assumption that the lek equivalent of foreign budgetary and/or balance of payments financing (excluding project and commodity loans, and excluding US$20 million BoP loan from the European Union that will be treated as foreign borrowing by the BoA for the purpose of the Program), converted at the program monitoring exchange rate of 135.2 lek per U.S. dollar, will amount, on a cumulative basis, from January 1, 2000 to:

End-June 2000 US$55 million
End-September 2000 US$55 million
End-December 2000 US$55 million
End-March 2001 US$66 million.

In cases when total foreign financing exceeds (falls short) of this projection, the target for the net domestic credit to the government and the net domestic assets of the Bank of Albania will be adjusted downward (upward), and for the net international reserves upward (downward), with the proviso that the upward adjustment to the NCG and NDA ceilings and the downward adjustment to the NIR floor should not exceed the lek equivalent of US$50 million, converted at the program monitoring exchange rate, of Lek 135.2 per U.S. dollar.

10.  The NIR floor will be adjusted upward (downward) and the NCG and NDA ceilings adjusted downward (upward) by any amount by which the lek equivalent of the Kosovo-related budget cost (converted at the program monitoring exchange rate of 135.2 lek per U.S. dollar) is lower than (exceeds) the amounts assumed under the program, on a cumulative basis, from January 1, 2000, to

End-June 2000 US$15 million
End-September 2000 US$15 million
End-December 2000 US$15 million
End-March 2001 US$15 million.

11.  The NCG ceiling will be adjusted downward for any excess in privatization proceeds over the programmed levels, on a cumulative basis, from January 1, 2000, to

End-June 2000 Lek 1.4 billion
End-September 2000 Lek 2.8 billion
End-December 2000 Lek 3.5 billion
End-March 2001 Lek 4.9 billion.

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

13.  The ceilings on net credit to the government will be adjusted upward for any new issuance of government instruments for recapitalization of banks, up to the amount of Lek 20 billion.

E.  External Debt and Arrears

14.  The limit on debt of 1–15 years applies to the contracting or guaranteeing by the government or the Bank of Albania, or by state-owned enterprises, of new nonconcessional external debt with an original maturity of more than one year and up to and including 15 years, with sublimits on external debt with an original maturity of more than one year and up to and including five years. The coverage of debt includes financial leases and other instruments giving rise to external liabilities, contingent or otherwise, on nonconcessional terms. Excluded from the limits are changes in indebtedness resulting from refinancing credits and rescheduling operations (including the deferral of interest on commercial debt), credits extended by the IMF, and credits on concessional terms, defined as those with a grant element of 35 percent or more calculated using the OECD Commercial Interest Reference Rates (CIRRs) for January 16–February 5, 2000. Debt falling within the limit shall be valued in U.S. dollars at the exchange rate prevailing at the time the contract or guarantee becomes effective.

15.  The limit on short-term debt applies to the stock of short-term debt contracted or guaranteed by the government or the Bank of Albania, or by state-owned enterprises, with an original maturity of up to and including one year. Excluded from the limit are changes in indebtedness resulting from 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.

16.  The prohibition on the accumulation of new external payments arrears applies to the change in the stock of overdue payments on short-term debt in convertible currencies with an original maturity of up to and including one year (spot, money market, letters of credit, and others) and medium- and long-term debt contracted or guaranteed by the government, public agencies, the Bank of Albania, from their level at end-December 1999. Accumulation of arrears arising from interest on the arrears stock outstanding as of December 1, 1999 is excluded from the prohibition on the accumulation of any new arrears.

F.  Tax Revenues

17.  Collection of total and the customs department tax revenue will be monitored on the basis of quarterly indicative floors. Tax revenues are defined as revenues collected by the central tax department and/or the customs department.

G.  Monitoring and Reporting Requirements

18.  Performance under the program will be monitored from information supplied monthly to the Fund by the Bank of Albania and the Ministry of Finance. The following information will be communicated monthly to the Fund by the Ministry of Finance: the summary fiscal table, including the overall budget deficit, on a cash and commitment basis, their issuance of Treasury bills including gross value and cash received, and privatization receipts; and by the Bank of Albania; the balance sheets of the Bank of Albania, and the consolidated accounts of the commercial banks; the monetary survey; the net domestic credit to the government; the NFA of the Bank of Albania; the foreign exchange cashflow of the Bank of Albania, including the level of official reserves; daily average exchange rates; trade flows; periodic updates of balance of payments estimates; information on the contracting and guaranteeing of new debt; information on the stock of short-term debt; and information on all overdue payments on short-term debt and on medium- and long-term debt. To ensure transparency and accountability in the use of budgetary funds for humanitarian relief, all financial aid donated to the government to cover relief efforts will be deposited in a special budgetary account in the Savings Bank-the Kosovo Account, and reports on the use of budgetary funds from this Account will be provided bi-weekly to the Fund by the Ministry of Finance.