Bogotá, Colombia
August 22, 2000

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

Dear Mr. Köhler,

1.  In the period since December 1999, when the extended arrangement was approved, the recovery of economic activity in Colombia has been confirmed, based on strong and broad based growth of both exports and domestic demand, and the central bank’s disinflation policy has remained on track to achieve the objectives set for 2000. Despite the strong signs of recovery, the number of Colombians that are out of work remains unacceptably high, and the government will take steps to ensure that the unemployment rate will decline. The external current account is stronger than projected, helped by higher oil prices, and the foreign exchange market has functioned well under the floating rate system. The fiscal consolidation plan is progressing as envisaged under the program, and the financial system has responded well to the restructuring programs, showing significant improvements in prudential indicators. The authorities are pursuing their structural reform agenda which will continue to be developed and evolve over the three-year period of the program. Most important for Colombia is the achievement of peace, and to enhance the near-term prospects for peace and social cohesion, the government recently presented to the nation and the international community its comprehensive plan to achieve this, the “Plan Colombia.”

2.  Notwithstanding that the decline of the Colombian economy in 1999, as measured by a GDP growth rate of -4.5 percent, was more pronounced than projected in the program (-3.5 percent), all performance criteria established for end-1999 and March 2000 were observed, except as discussed below. In addition, the external current account deficit declined to 1.1 percent of GDP in 1999 (compared with 1.3 percent of GDP in the program), and inflation fell to 9.2 percent (compared with a target of 11 percent). Despite the negative impact on tax collections of the deeper than expected recession, the combined public sector deficit was 5.4 percent of GDP, well below the projected level of 5.9 percent of GDP.

3.  In terms of performance criteria, the net international reserves at the end of 1999 and March 2000 were above the minimum levels set in the program, and the overall fiscal deficit was below the ceilings for these dates. The performance criterion on net disbursement of medium- and long-term public sector external debt for end-1999 was observed with a considerable margin that in large measure reflected the lower than projected fiscal deficit; the ceiling established for March 2000 also was observed. The public sector’s short-term external debt was below the ceiling both in December and March. The outstanding stock of net domestic assets (NDA) of the central bank at the end of 1999 was above the ceiling, reflecting demand for base money that was temporarily in excess of the projected level related to the Y2K problem, a possibility foreseen in the program. The NDA was below the established ceiling again in March 2000.

4.  The Colombian authorities confirm the program objectives of seeking to restore real GDP growth in 2000 to 3 percent and maintain the annual inflation target of 10 percent. Despite a projected shortfall in non-oil revenues, a deeper than expected recession in 1999, and the need to attend to some unforeseen expenditures in 2000, the authorities reaffirm their commitment to meet the program target of an overall deficit for the nonfinancial public sector (NFPS) of 3.6 percent of GDP in 2000, with a combined public sector deficit of 3.7 percent of GDP. Central government expenditures will be 1.4 percent of GDP higher than originally expected due to unforeseen, mostly nonrecurrent, requirements stemming from the need to address problems in three areas: the internal conflict; the high level of unemployment; and the fiscal problems of some territorial governments. Nevertheless, the program’s fiscal target will be achieved due to public sector wage increases below projected inflation, higher than expected oil revenues (0.7 percent of GDP), expenditure measures introduced in May, and the impact of savings in other areas. If revenue were to fall below current projections, the authorities will make the necessary expenditure cuts to ensure that the fiscal target is fully met.

5.  The authorities are proposing that the overall deficit of the central administration be measured on a commitment basis for the purpose of monitoring the program. This will help fiscal management in Colombia by fully reflecting all budgetary commitments in the year in which they are incurred. It also will allow the executive to better control expenditure requests that come late in the year; such requests have often been accommodated in the past by pushing their execution to the next fiscal year, giving rise to budgetary carryovers that have been difficult to control. A deficit on a commitment basis also will make the budgetary process more transparent and efficient by abandoning the hybrid accrual and cash basis that has been used in the past. The government has worked with Fund staff to ensure that the mechanisms are in place to guarantee accurate reporting of all budgetary commitments.

6.  At present , the authorities do not expect that the plans drawn up for privatization of public enterprises and banks in 2000 can be fully executed, as explained below. Lower than projected privatization receipts will have implications for the financing of the public sector deficit. According to the provisions in the program, the government will seek compensatory external financing in an amount of up to 50 percent of the shortfall in privatization proceeds. Additional financing also would be required, which the authorities have sought to secure in the international financial markets and by accelerating program lending operations that are under preparation by the multilateral lending institutions. To allow for the additional financing the authorities are proposing that the program ceiling on medium- and long-term external debt for the end of 2000 be set US$300 million higher than the indicative ceilings presented in the program. This increase would correspond to about half of the amount of privatization receipts expected from the sale of the main electricity transmissions company, whose privatization is being shifted from 2000 to 2001. If opportunities arise to pre-finance the needs for the year 2001 during the last half of 2000, the government will discuss with the Fund the necessary changes in the external indebtedness ceilings; the proceeds of any such financing would be kept in foreign exchange abroad until they are needed in 2001.

7.  Significant progress has been made in recent months in the peace process. The discussion methodology now contemplates the possibility of implementing partial peace agreements, which may require a temporary increase in the NFPS deficit in order to ensure their adequate implementation. While the government expects that progress on the peace front will strengthen the underlying fiscal position, the authorities will discuss with the Fund any budgetary changes that may be required should the need arise.

8.  The Colombian government recently has made public its multi-year project entitled “Plan Colombia” which integrates its strategies for ending the internal conflict, reducing the scope of narco-trafficking, and dealing with the serious social consequences of these problems. A number of bilateral donors and lenders have indicated that they will support the “Plan Colombia,” and the Colombian authorities are proposing that the program ceilings on the fiscal deficit and the net disbursement of medium- and long-term debt be adjusted upwards, by the amount of concessional loans disbursed in support of this plan. The domestic contributions to the plan are being incorporated into the government budget as part of its fiscal program.

9.  With respect to monetary policy, the central bank continues to follow a strategy of inflation targeting, with the growth of base money as an intermediate target. The monetary authorities consider that the inflation targeting strategy is compatible with the use of an intermediate target, as long as the latter is subordinate to the inflation goal. Substantial effort is being devoted to improving the inflation forecast capability and the knowledge of the transmission mechanisms of monetary policy. At present, the projections of the central bank indicate that inflation will be on target by the end of the year and that the 8 percent target for 2001 also will be achieved. However, an increase in inflation has been registered during the first part of 2000 due to a temporary rise in some food prices and higher domestic fuel prices. In fact, all four measures of annual core inflation calculated by the central bank have remained below the target in recent months, and the central bank’s forecasts of core inflation point to levels well below the official target for December 2000.

10.  So far this year, cash balances held by the public have grown more than projected in the program. Since the authorities consider that the shift to higher holdings of liquid assets is permanent, related to exogenous shocks to money demand (e.g., to the expansion of the financial transactions tax base earlier this year), the reference monetary base has been raised somewhat for the rest of 2000; this would not impede the achievement of the inflation goals for 2000 and 2001. Accordingly, the authorities propose that the performance criterion on NDA for September and December 2000 be set somewhat higher than the indicative target presented in the program, while the target for the net international reserves would remain as indicated earlier.

11.  Since September 1999, the Colombian peso has been allowed to float against the dollar. The transition to the floating system was smooth and the exchange rate has since remained relatively stable. The central bank has introduced an auction system under which market participants (banks and the treasury) bid for options to transact foreign exchange with the central bank. The experience with this system has been successful and helped the bank exceed the NIR targets in December 1999 and March 2000. Presently, Colombia exhibits a strong international reserves position, and given the balance of payments projections, the central bank expects to be able to meet the NIR target for 2000. To ease the access to external financing, the central bank in May reduced to zero the nonremunerated deposit requirement (at the central bank) on external loan proceeds.

12.  Since the middle of 1999, there has been a positive evolution in both liquidity and solvency indicators in the Colombian financial system. The average capital adequacy ratio in June was 11.2 percent, approximately 1.2 percentage points higher than the observed figure in August 1999, when it was as its lowest. Capital strengthening has been achieved primarily due to the implementation of programs under the financial institutions guarantee fund (Fogafin), both in public and private financial intermediaries. The nonperforming loan indicator, though still at undesired levels, has improved from 16.1 percent in November 1999 when it was at its highest level to 10.5 percent in June 2000, while provisions have increased as a percentage of past-due loans. The former result was due to the combination of the process of loan restructuring required under Fogafin recapitalization programs and the recovery in economic activity, while the latter is mainly the result of more stringent provisioning rules imposed by the banking superintendency. The authorities plan to increase the capitalization of the public banks by an additional 1 percent of GDP (with an annual fiscal carrying cost of some 0.1 percent of GDP) to prepare them for sale on the schedule envisaged in the program.

13.  Most of the structural reform actions to be completed by June 2000 have been implemented. The proposal for the creation of a territorial government pension fund was approved through Law 549 at the end of 1999. Most of the regulations to implement the provisions of the financial sector reform law enacted in July 1999 have been issued, with the final regulation to be issued shortly. The draft legislation to organize lottery and gaming activities to help boost the territorial governments’ pension reserves was presented to congress as scheduled and legislation to strengthen territorial government finances by means of limiting their current expenditures has been passed. The proposal for a constitutional reform which delinks revenue transfers to territorial governments from the current income of the central government was submitted to congress last fall as envisaged under the program, but it was withdrawn after initial discussions. The government agreed to restructure the proposal and it was re-submitted in March 2000. Regarding the tax reform, a proposal was presented to congress in March 2000, as envisaged in the program. The presentation to congress of the proposal for a second generation social security reform, originally scheduled for December 1999 has been postponed to provide for technical improvements in the proposal and to allow time to build public consensus on the contents of the reform. The government now intends to present it to congress before the end of the year.

14.  The Colombian authorities confirm their determination to pursue and deepen the structural reform process over the three-year period of its program. To that end several reform proposals are currently before congress (as noted above) or under preparation.

15.  The tax package currently before congress proposes a gradual lowering of the marginal income tax rates from 35 to 32 percent, and the creation of a unified income and value-added tax for small business (to help prevent tax evasion), as well as other measures to close loopholes in the income and value-added taxes.

16.  With the purpose of protecting the viability of the public finances, while increasing the coverage in the provision of education and health services, the government has submitted a constitutional amendment to the congress aimed at modifying the present scheme for revenue transfers to territorial governments (situado fiscal and participaciones municipales). The proposed reform delinks the transfers from the current revenue of the government, so as to guarantee their stability and allow more flexibility of the central government finances. Under the government’s proposal, the transfers would increase by 1.5 percent annually in real terms in order to allow for the need to expand services, notably in education and health.

17.  In regard to the pension reform, the government will present to congress before the end of the year its proposal to eliminate the sources of future deficits of the social security institute in order to guarantee its financial viability in the medium term.

18.  In regard to the privatization program, significant advances have been made in bringing several major enterprises near the point of sale. However, it is likely that the original schedule will be affected by the intensification of attacks on strategic locations of the electricity network. As a result, the sale of the main electricity distribution company, ISA, would be postponed to 2001, but the government expects that the sale of the electricity generating firm, ISAGEN; the large coal mine, Carbocol; and the regional telephone company in Bogota, ETB, will be completed before the end of 2000. The government continues to pursue its efforts to privatize the public banks, as noted above, and bring them to the point of sale by the end of the year. On the other hand, the sale of the other electrical distribution companies is less advanced than expected and is likely to bring less revenue than anticipated.

19.  In addition, the government is seeking to build a stronger partnership between the executive and congress in the area of fiscal policy. To this end, it will propose to congress before the end of the year a fiscal responsibility law to promote the long-run sustainability of the public finances, both at the central and territorial (departmental and municipal) levels of government. More fundamentally, the structural reform policies regarding substantive economic and social issues, as well as employment, are currently the subject of political discussions in Colombia; mainly through round table discussions (mesas de concertación) among representatives from congress and wide segments of society. The government expects that concrete proposals will emerge from these roundtable fora in the last half of the year.

20.  The government is committed to the fiscal adjustment path agreed under the program. On this basis, the authorities submitted to congress in late July 2000 a budget for 2001 that is consistent with a nonfinancial public sector deficit of at most 2.5 percent of GDP and a combined public sector deficit that is consistent with the program.

21.  The Colombian authorities reaffirm their policy commitments under the program supported by the EFF arrangement approved by the IMF Executive Board last December, request completion of the first review thereunder, and will conduct the second review with the Fund under the three-year EFF arrangement by December 20, 2000.

Sincerely yours,

Colombia—Technical Memorandum of Understanding

1. This memorandum sets out the definition of concepts, specific performance criteria (PCs) for September and December 2000, the structural benchmarks defined to date for the remaining period of the program (SBs), and assumptions that apply under the first-year program supported by extended arrangement.

A. Performance Criterion on the Overall Balance of the Combined Public Sector1
	Floor2 (In billions of Col$)
Overall balance of the combined public sector, from January 1, 1999 to:
September 30, 2000 (performance criterion)	-13,700
December 31, 2000 (performance criterion)	-14,550
1As measured by the net financing requirement defined below. Combined public sector as defined below. 2Minimum cumulative balance of the combined public sector.

2. The overall balance of the combined public sector (PS) is defined as the sum of the overall balances of the nonfinancial public sector (NFPS), the operating cash result (quasi-fiscal balance) of the Banco de la República (BR), the overall balance of Fondo de Garantías de Instituciones Financieras (FOGAFIN), and the net fiscal costs borne by the central administration related to financial sector restructuring. The NFPS consists of the general government and the public enterprises; the general government includes the central government, the territorial governments, and the social security system; the central government includes the central administration and the national decentralized agencies as indicated below. The net fiscal costs borne by the central administration related to financial sector restructuring are defined to include interest payments and amortization of the bonds used to compensate financial entities for the mortgage debt reductions approved by the congress in December 1999, the interest payments on the bonds used to recapitalize public banks, and the costs of closing Caja Agraria.

The Combined Public Sector PS = NFPS1 + FOGAFIN + quasi-fiscal BR + net fiscal costs borne by the CG related to bank restructuring NFPS = general government (GG) + public enterprises (PE) GG = central government (CG) + territorial governments (TG) + social security CG = central administration + national decentralized agencies TG = territorial government + territorial decentralized agencies 1Excludes net fiscal costs borne by CG related to bank restructuring.

3. For any given calendar quarter, the overall PS balance is measured, in Col$, as the sum of: (i) its net domestic financing, (ii) its net external financing, and (iii) privatization proceeds, as defined below. Items denominated in foreign currency will be converted into pesos at the actual exchange rate.

4. The PS net domestic financing comprises (i) the change in its net credit from the financial system, excluding bonded debt; (ii) the change in its bonded debt (including domestic bonds denominated in or indexed to foreign currencies) net of valuation changes; (iii) the change in the budget carry-over (rezago presupuestario, which includes cuentas por pagar and reservas de apropiación) of the central administration and, from March 2000, the change in the floating debt (cuentas por pagar) of the social security system (Instituto de Seguro Social, Cajanal, and Caprecom) and main public enterprises; Ecopetrol, Carbocol, Telecom, the national electricity companies (ISA, ISAGEN, and the national electricity distributors), and the national coffee fund; (iv) the change in the amount of public funds administered by Fiduciarias; and (v) the operating cash result of the BR. Any capitalization of interest on new issues of government bonds from September 1, 1999 and the accrual of the inflationary component of indexed bonds will be included as (interest) expenditure for the purpose of measuring the PS deficit.

5. The financial system comprises the banking sector, saving and loan institutions (corporaciones de ahorro y vivienda), finance corporations (corporaciones financieras), FEN, IFI, finance and leasing companies (compañías de financiamento comercial), Bancoldex, Finagro, and Findeter. The banking sector includes the BR, the commercial banks, and BCH.

6. The PS net external financing is defined as the sum of (i) disbursements of project and nonproject loans, including securitization; (ii) proceeds from bond issues abroad; (iii) the net changes in short-term external debt; (iv) any change in arrears on external interest payments; minus (v) cash payments of principal on current maturities for bonds and loans; (vi) cash payment to settle any external arrears; (vii) any prepayment of external debt; and (viii) changes in financial assets held abroad by the PS.

7. Privatization proceeds are defined as the cash payments received by the PS, converted to Col$ at the actual market exchange rate of each transaction. Nonrecurrent fees for concessions of public services, such as in the telecommunications sector, are treated as privatization proceeds. For purposes of the program, such fees will be accounted for over the concession period distributed in equal annual amounts. Proceeds from decapitalization of public enterprises will be considered as privatization. To the extent the purchasers of public enterprises assume their debts, the net financing used by these enterprises during the program period until their sale will be deducted from the net financing of the PS; if the PS assumes the debt, the net financing used by the enterprise during the program period before the sale will remain outstanding as part of the financing of the PS.

8. Adjustments. The ceiling on the overall combined public sector deficit will be adjusted upwards, and the ceiling on net disbursements of medium- and long-term external debt of the public sector will be adjusted upward (see below), by the full amount of any concessional loan disbursements in support of the Plan Colombia. A loan will be defined as concessional if it has at least a 35 percent grant element using the commercial interest reference rate (CIRR) as discount rate.

A. Performance Criterion on the Net Domestic Assets (NDA) of the BR
	Ceiling1 (In billions of Col$)
Outstanding stock of net domestic assets as of:
September 30, 2000 (performance criterion)	-8,500
December 31, 2000 (performance criterion)	-7,100
1 Maximum level of end-of period outstanding stock of net domestic assets of the BR. This level is calculated as the difference between the upper band of the central bank’s monetary base corridor and the floor of the NIR established in Section III below.

9. The NDA of the BR are defined as the difference between the monetary base and its net international reserves (NIR) valued in Col$ at an accounting exchange rate. The monetary base consists of currency in circulation, including cash-in-vaults at financial institutions, and the sight deposits of the financial system at the BR.

10. The NIR of the BR (reservas de caja) are equal to the balance of payments concept of net international reserves excluding causaciones (accrued, but unpaid, interest on reserve assets) and are the U.S. dollar value of gross foreign reserves of the BR minus gross reserve liabilities.

11. Gross foreign reserves of the BR comprise (i) gold, (ii) holdings of SDRs, (iii) the net position in the FLAR, and (iv) all foreign currency-denominated claims of the BR. Gross foreign reserves exclude participation in international financial institutions (including Corporación Andina de Fomento (CAF), IDB, IBRD, IDA, and the Caribbean Development Bank), the holdings of nonconvertible currencies, and holdings of precious metals other than gold. The pesos andinos are considered to be part of Colombia’s gross foreign reserves. Gross reserve liabilities of the BR are defined as the sum of (i) all foreign currency-denominated liabilities of the BR with an original maturity of one year or less, (ii) liabilities to the Fund, (iii) any net position on foreign exchange derivatives with both residents and nonresidents undertaken directly by the BR or by other financial institutions on behalf of the BR, (iv) any purchases from the Latin American Reserve Fund (FLAR), (v) any increase in medium-and long-term external debt of the BR over and above US$125 million, which is the level of the outstanding debt on October 1, 1999, and (vi) any foreign currency deposits in the BR by residents, including financial institutions. Options to sell foreign exchange to the central bank acquired by financial institutions and the treasury at the monthly auctions to build the central bank’s reserves (mecanismo para acumular reservas internacionales) will be added to reserves when they are exercised.

12. Adjustments. Adjustments to the ceiling on the NDA of the BR are described in Section III (13) below.

A. Performance Criterion on NIR of the BR
	Target1 (In millions of U.S. dollars)
Outstanding stock as of:
September 30, 2000 (performance criterion)	8,250
December 31, 2000 (performance criterion)	8,570
1 Minimum level of NIR of the BR. NIR as defined in Section II above.

13. Adjustments

(a) The quarterly NIR targets may be adjusted downward by US$500 million, as necessary, to help secure orderly currency market operations after the September 1999 floating of the peso. The amount of any overperformance on the adjusted NIR target for December 31, 1999, up to US$500 million, can be carried forward into 2000 as follows: the adjusted NIR target for March will be subject to an additional downward adjustment of one-half of the overperformance; the adjusted target for June of one-quarter of the overperformance; and the adjusted target for September of one-eight of the overperformance. In case of such adjustments to the NIR, the NDA ceilings established above in Section II. A will be raised using the following marginal adjustments:

Loss of NIR Relative to Baseline (In US$ million)	Marginal Increase of NDA Ceilings1 (In percent of observed NIR loss)
Between 0 and 200	100 percent
Between 200 and 300	90 percent
Between 300 and 400	80 percent
Between 400 and 500	70 percent
More than 500	60 percent
1These refer to the marginal adjustment of the NDA ceiling for each successive US$100 million loss of NIR relative to the baseline. For example, a loss of US$300 million relative to the baseline would imply an upward adjustment of the NDA ceiling by the equivalent in Col$ of US$290 million.

(b) In case there is a shortfall from the amount of net external financing of the combined public sector programmed for 2000 (the sum of privatization proceeds and changes in external debt, as defined in Section I, paragraphs 6 and 7 above and shown in the attached Table 1), the quarterly targets for the NIR in 2000 will be subject to a further downward adjustment of any shortfall up to a cumulative US$600 million through March, and up to a cumulative US$900 million for the rest of the year. The ceilings on the NDA of the BR will be raised by the equivalent in Col$ of any downward adjustments in the NIR targets.

(c) In the case of an excess in the amount of net external financing of the combined public sector with respect to the baseline (Table 1), the quarterly targets for NIR will be adjusted upward by the full amount of the excess less US$50 million (such excess could be avoided by increasing the public sector’s assets abroad, as indicated in paragraph 6 (viii) above). The ceiling on the NDA of the BR will be lowered by the equivalent in Col$ of any such adjustment in the NIR target.

B. Performance Criterion on the Net Disbursement of Medium- and Long-Term External Debt by the Public Sector1
	Ceiling (In millions of U.S. dollars)
Cumulative net disbursement of external debt by the public sector from January 1, 1999 to
September 30, 2000 (performance criterion)	3,200
December 31, 2000 (performance criterion)	3,500
1 The public sector includes the PS as defined above and the financial public sector, including second-tier banks.

14. This ceiling applies to the net disbursement (gross disbursement minus amortization/redemptions) of debt of the public sector (financial and nonfinancial) of nonconcessional external debt of maturity of over one year. The changes in the external debt will be valued in U.S. dollars at the exchange rate prevailing at the time of each transaction.

15. Adjustments. To the extent there is a shortfall in privatization proceeds relative to the program baseline shown in the attached Table 1, the ceiling will be adjusted upward by 50 percent of the shortfall.

16. Guarantees. The government will maintain the policy of not guaranteeing private sector external debt.

C. Performance Criterion on Change in the Outstanding Stock of Short-term External Debt of the Public Sector1
	Ceiling (In millions of U.S. dollars)
Cumulative net disbursement of short-term external debt of the public sector from January 1, 1999 to:
September 30, 2000 (performance criterion)	70
December 31, 2000 (performance criterion)	70
1 Short-term debt defined as all debt with an original maturity of one year or less, excluding normal trade financing. Public sector includes the PS as defined above and the financial public sector except transactions that affect the reserve liabilities of the BR.

17. To be completed by September 30, 2000

• Present to congress the 2001 budget consistent with a nonfinancial public sector deficit of at most 2.5 percent of GDP.

18. To be completed by December 31, 2000

• Present to congress a draft fiscal responsibility law.

• Present to congress a proposal for a second generation social security reform (modifying law 100 of 1993).¹

19. To be completed by March 31, 2001

• Present to congress a proposal on territorial tax policy, granting more fiscal autonomy to territorial governments (territorial tax reform).

20. To be completed by December 31, 2001

• Full disinvestment of all remaining public banks, excluding Banco Agrario.

21. To be completed by September 30, 2002

• Complete process of bringing provisioning standards of the financial institutions to international levels.

• Latest date for accepting the obligations of Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement.

 

Table 1. Colombia: Baseline Assumptions for Net External Financing of Combined Public Sector
	Mar. 2000	Jun. 2000	Sep. 2000	Dec. 2000
	(In millions of U.S. dollars)
Net external financing of combined public sector (cumulative in 2000)1	1,218	2,087	2,452	3,197
Cumulative privatization proceeds	385	1,265	2,235	2,785
Cumulative net external financing of the combined public sector2,3	833	822	217	412
1Includes only external sources. 2Including concession revenues. 3For purposes of the program the net external financing for the first quarter of 2000 includes the US$500 million of prefinancing obtained in November 1999 that is being held abroad until the first quarter of 2000.