Tirana, January 12, 2001

Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street NW
Washington, D.C. 20431
U.S.A.

Dear Mr. Köhler:

1. The authorities of the Republic of Albania held discussions with Fund staff during
October 19-31, 2000 in the context of the midterm review of the economic program supported by the third annual arrangement under the Poverty Reduction and Growth Facility (PRGF). The program is on track, with all end-September 2000 quantitative performance criteria observed. The privatizations of two mid-sized enterprises were completed on October 4, 2000 and the privatization advisor for the Savings Bank was appointed in December (both end-September performance criteria). The tender for privatization of the Savings Bank (an end-November performance criterion) has been delayed in light of the complexities noted by investment banks and other delays outside the control of the government of Albania. Based on the completion of the measures under the first two performance criteria (albeit with a short delay) and our continuing efforts in privatizing the Savings Bank, we request waivers for the nonobservance of the three structural performance criteria.

2. The attached Supplementary Memorandum of Economic and Financial Policies (MEFP) describes our economic program and key policy measures for the period ahead. In particular, we have reached understandings with Fund staff on the 2001 budget and on measures for the privatization of the Savings Bank. We have already implemented the three prior actions for the completion of the review. Based on the performance of the program to date and our proposals for the period ahead as described in the MEFP, we request the completion of this review.

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

Sincerely yours
/s/ Ilir Meta Prime Minister			/s/ Anastas Angjeli Minister of Finance			/s/ Shkëlqim Cani Governor, Bank of Albania

Supplementary Memorandum On Economic And Financial
Policies Of The Government Of The Republic Of Albania For The
Completion Of The Midterm Review Of The Third Annual
Arrangement Under The PRGF

I. Introduction

1. The favorable performance of Albania's economy has continued in 2000, benefiting from our efforts to maintain macroeconomic stability and implement policies in line with the PRGF supported program. GDP growth is now estimated at about 7¾ percent in 2000, somewhat higher than expected earlier, thanks to strong domestic demand resulting from improved business confidence and rapid growth in private remittances. Inflation has remained subdued, reflecting prudent financial policies, productivity growth, and the continued strength of the exchange rate relative to European currencies. In a virtuous circle, low inflation has in turn helped maintain strong demand for the lek. Exports, which were adversely affected by the Kosovo crisis in 1999, have started to recover, and will strengthen further with the resumption of activity in the chromium and steel sectors, following their transfer to foreign investors, and increased exports of textiles and shoes, reflecting improved regional stability. The current account deficit in 2000 is estimated to have declined as a share of GDP relative to 1999, with private transfers more than offsetting the higher trade deficit. This, together with the continuing support of foreign donors for our development programs and increased privatization receipts, has strengthened the balance of payments position. The Bank of Albania's (BoA) official reserves are at a comfortable level of about 4½ months of imports.

2. We have achieved impressive results in improving revenue collection in 2000. By implementing measures to improve customs and tax administration agreed under the PRGF, we have been able to boost tax collection by about 30 percent relative to 1999 without increasing any tax rate, while reducing maximum import duty rate from 20 percent to 18 percent on January 1, 2000. We have reduced smuggling and corruption, improved the valuation of imports, accelerated the collection of customs debt, and strengthened the discipline of companies operating under special customs regimes. Better cooperation between tax and customs administrations has also been effective in fighting tax evasion. In the internal tax administration, major efforts to improve enforcement have resulted in an increase in the number of registered active taxpayers of VAT and small business tax by 17 percent and 28 percent, respectively, compared with 1999.

3. Expenditure priorities have been realized while keeping the deficit below the program ceiling. The original budget foresaw a strong increase in expenditure on public investment as well as health and education. In the revised budget we raised investment in roads and schools, in connection with the release of a foreign grant, and increased expenditure on operations and maintenance. The second tranche of the EU Kosovo-related grant has been approved, and we are using the proceeds to finance investment in infrastructure damaged during the Kosovo crisis. We have met the end-September performance criteria on domestic financing of the deficit, and we are confident that the end-December indicative target will also be met (Table 1).

4. We have implemented further measures to improve expenditure management. To strengthen expenditures control, we have signed a contract with an international auditing firm for an expenditure tracking exercise, which is now underway. Moreover, in the 2001 budget we have introduced a more detailed economic classification of expenditure, including adjustment of the government chart of accounts, and have appropriately trained the staff members of the Ministry of Finance (MoF) and spending agencies.

5. Macroeconomic stability and rising confidence have allowed the BoA to relax monetary conditions and gradually reduce interest rates. The repo rate declined significantly, to about 4¾ percent in October; the three-month T-bill rate to about 7¾ percent; and the deposit rate for the same maturity at the Savings Bank with some lag, to 6¾ percent, with prospects for further declines of deposit rates in the months ahead. Moreover, the last direct instrument of monetary policy, the minimum interest rate on three-month deposits, was eliminated in September and the BoA now relies primarily on open market operations in conducting monetary policy. Nonbank participation in the T-bill market has also increased significantly. Declining interest rates and a better business climate have led to higher private sector credit growth, particularly in the construction sector and for housing. Some banks have reportedly reduced lek lending rates recently.

6. We have made substantial progress in structural reforms, although some privatization measures have been delayed. In the enterprise sector, we have successfully sold Albanian Mobile Communications and two mid-sized companies. We will complete the sale of the remaining three mid-sized companies over the next few months. We have announced the tender for the second mobile phone license; approved an action plan for privatizing Servcom and submitted to parliament the law on the privatization of the strategic part of that company; and provided office space for the registry for collateralized property. The 1999 audit of Albtelekom according to international standards could not be completed, however, owing to difficulties in preparing an inventory of the company's fixed assets, an issue that will be addressed in the company's 2000 audit. In the banking sector, we have transferred the National Commercial Bank (NCB) to foreign investors, but preparations for privatizing the Savings Bank are behind schedule. Specifically, the chief accounting and operating officers were appointed with some delay in October, as was the privatization advisor in December. On the positive side, the audit of the 1999 financial statements for the Savings Bank has confirmed their compliance with international standards. The bank has continued to collect outstanding classified loans. It has further reduced its payroll and has identified branches that could be transferred to the post office or closed. Table 2 provides information on the status of structural reform under the program.

7. The preparation of a poverty reduction strategy is proceeding well, following the completion of the interim Poverty Reduction Strategy Paper (PRSP). The U.K.-based Institute for Development Studies (IDS) carried out a stakeholder analysis and provided the government PRSP Working Group, which is composed of 21 deputy ministers and department heads, with options for a participatory process. This process has now been elaborated and was presented to a broad cross-section of the Albanian society at a two-day workshop in early November. The Carter Center has agreed to assist the government in the facilitation of civil society participation. An information and media campaign was launched in November 2000, with support from UNICEF, to raise the public's awareness of the process.

II. The Government's Policies

A. Objectives

8. The government's objectives are to maintain the economy on a strong sustainable growth path and reduce the poverty of those most in need. To achieve these objectives we have to preserve macroeconomic stability, deepen the process of structural reform, attract foreign investment, and strengthen government programs for alleviating poverty.

9. We will demonstrate our commitment to poverty alleviation in a PRSP that will be prepared by mid-2001, with the participation of civil society representatives and foreign donors. The participatory process has several components, including (i) a dialogue with civil society advisory groups in the context of the Medium-Term Expenditure Framework (MTEF) in the sectors of health, education, labor and social affairs, and agriculture; (ii) a dialogue with the representatives of private businesses; and (iii) a dialogue between the central and local governments. In cooperation with the World Bank, we will formulate a new Rural Strategy, through a participatory process, which will ensure that issues of rural poverty and development are fully addressed in the PRSP. The PRSP will present our long-term poverty alleviation goals and the intermediate indicators that will be monitored to assess progress toward achieving these goals. The cost implications of poverty reduction will be integrated fully and transparently into the budget. Work has also started on an updated poverty assessment based on both quantitative and qualitative data. Following the 2001 population census in April, the World Bank will help us in establishing a poverty profile based on a Living Standard Measurement Survey, the results of which will be available in early or mid-2002 and will be used for an updated PRSP in 2002.

10. Macroeconomic policy for 2001 will aim at supporting strong GDP growth as well as maintaining low inflation and a prudent level of official reserves. To achieve the growth target of about 7¼ percent, we will continue forcefully with reform and privatization in the financial and enterprise sectors, and approve a prudent 2001 budget that further strengthens revenue collection and allows for increased spending on investment, health, and education. We expect that inflation will rise to a range of 2-4 percent, a level that will allow smooth relative price adjustments characteristic of a rapidly growing economy. External reserves are expected to remain at the comfortable level of 4½ months of imports. We are aware that the realization of these targets depends heavily on our success in normalizing electricity supply by implementing the measures specified in paragraph 23. We will monitor developments closely and stand ready to discuss with Fund staff appropriate revisions in the macroeconomic framework if necessary. Specific targets for 2001 are tabulated below.

	1999		2000	2000		2001	2001
			Prog.	Proj.		Prog.	Proj.
			May-00			May-00
GDP growth (in percent)	7.3		7.0	7.8		8.0	7.3
Inflation (average; in percent)	0.4		1.5	-0.2		3.0	2.5
End-period gross official reserves  (In millions of U.S. dollars)  (In months of imports of goods  and services)	481 4.1		500 4.6	550 4.4		535 4.5	620 4.6
External current account deficit  (In percent of GDP)	8.0		8.4	7.0		7.8	7.3
General government deficit  excluding foreign-financed projects  of which domestic borrowing  (In percent of GDP)	11.5 8.2 5.2		9.4 5.7 4.3	9.5 5.8 3.3		8.7 4.5 3.5	9.2 5.2 2.7

B. Fiscal Policy

11. We will continue with gradual fiscal consolidation while pursuing our objectives of raising public investment and spending on poverty-related programs. The 2001 budget envisages an overall budget deficit of 9.2 percent of GDP, down from about 9.5 percent in the revised 2000 budget. Excluding foreign-financed investment projects, the deficit will decline from 5.8 percent to 5.2 percent of GDP. Domestic borrowing requirements will be limited to Lek 15.8 billion (2.7 percent of GDP), which is consistent with substantial scope for growth in private sector credit (about 32 percent). As the privatization receipts are likely to exceed the conservatively estimated amount of 1.7 percent of GDP, we expect to have more leeway for reducing domestic borrowing than envisaged under the budget. If these proceeds turn out to be more than ¾ percentage point of currently projected GDP for 2001 above the budgeted amount, we will discuss with the staff, in the context of negotiating a possible new arrangement, the appropriate use of these proceeds. In line with the ceilings envisaged under the program (see Table 1), foreign borrowing will be limited largely to resources provided on concessional terms by international organizations and bilateral donors. To address the risks of weaker-than-expected revenue performance, we will use the reserve and contingency funds sparingly, implement several investment projects only if line ministries meet their targets for collecting fees, and stay ready to cut other investment expenditure and expenditure on operation and maintenance, if necessary. The 2001 budget, consistent with the understanding reached with the staff, was approved by parliament in December (a prior action for completing this review).

12. We will make further efforts to strengthen both customs and tax administration to compensate for envisaged tax rate cuts and to meet the 2001 revenue target. The 2001 budget incorporates a rise in the tax revenue to GDP ratio by over ½ percentage point of GDP, while the profit tax rate is reduced from 30 percent to 25 percent. The maximum import tariff rate as of January 1, 2001 will be cut from 18 percent to 15 percent, and the lowest tariff rate from 5 percent to 2 percent. To encourage tourism, we will also reduce the border tax for foreigners. For road safety and environmental reasons, we will restrict imports of very old cars, improve valuation of used cars, but will continue to tax new cars at the top duty rate. We realize that at this stage we cannot reduce the Solidarity Tax further. To reduce pressures on granting fiscal exemptions, as a prior action for completing this review we will amend the free trade zone act to abolish the profit tax holiday. Moreover, we will clearly instruct our negotiators for the water supply project in Elbasan and for the airport terminal to reject any tax incentive demands from potential investors.

13. Regarding internal tax collection, we have decided to implement the following measures:

• We will amend the VAT law by December 2000 to increase the VAT threshold from Lek 5 million to 8 million, and adequately adjust upward the ceiling for the small business tax, with an overall positive effect on revenues. The carry-forward period for VAT credit claims will be shortened from six months to one month for exporters. For all taxpayers, we will adapt auditing process so that audits commence as soon as a VAT return indicating a credit is received. We will introduce a statutory time limit of two months (one month for exporters) for the release of VAT refunds, with interest payment in cases of late release, and will discontinue the practice of releasing refunds in installments. Moreover, for large investment projects, we will approve a deferred payments system for VAT on imports of machinery and other equipment.

• The budget will provide adequate resources to improve VAT operations—especially collection, refund, and audit—and extend the computerized VAT administration system to other main cities (Elbasan, Fier, Korça, Lushnje, Shkoder, and Vlore) by March 2001. We will expand the current system of selected cross-checking of VAT invoices.

• To improve its performance, the Large Taxpayers Unit (LTU) will report directly to headquarters as of July 1, 2001. All large firms (with a turnover above Lek 200 million) with their seat in Tirana will file and pay their tax liabilities in the LTU as of January 1, 2001. The March 1998 ministerial decision to split large enterprises' filing and payment of VAT liabilities in the district offices where their branches are located will be repealed as of January 1, 2001. We will review the LTU procedures and organization, update the manuals prepared for the VAT, and develop manuals for income tax, profit tax, and excise tax procedures by end-2001. An integrated computer system to support the work of the LTU will be developed by March 2002. We will provide suitable office facilities for the LTU by end-September 2001 (structural benchmark).

• We will amend the VAT regulation and require all retailers in hotels, restaurants, and several other sectors to issue VAT invoices for all sales (currently, these are issued only for transactions above Lek 10,000). By June 1, 2001 we will complete a study on mandatory introduction of cash registers at the retail level.

• We will introduce more secure excise stamps (banderoles) for cigarettes and alcohol as of January 2001, and implement the action plan to curb smuggling in cigarettes as agreed between the tax administration, the police force, and the Ministry of Defense as of November 1, 2000.

• We will impose an excise on import and production of alcohol, in addition to those on alcoholic beverages.

• To improve relations with taxpayers, we will ensure that tax officers strictly follow the rules prescribed under the profit tax law on advance payments and will reimburse taxpayers after the submission of final returns within the statutory deadlines. With support from the German and British governments and the Fiscal Affairs Department of the Fund, we are continuing the training program to educate selected tax officials, who will in turn function as trainers in the Tax Department.

14. In the area of customs administration, we will continue with the implementation of measures introduced in 2000. To further streamline customs administration and to augment revenue, notwithstanding the planned cuts in import tariffs, we will take the following measures:

• The Internal Audit Unit (IAU) will produce monthly reports on the implementation of valuation methods. Based on these reports, the Director General will take corrective measures, to address the issues raised by the IAU and send a monthly report on these measures to the Minister of Finance.

• We will implement an annual appraisal system for all customs personnel by end-December 2000, in consultation with the customs assistance mission of the European Union (CAM-A). We expect that this measure—along with the reward and bonus schemes implemented in mid-2000—will contribute to further lowering corruption and raising the professionalism and commitment of the customs personnel.

• We will continue to control companies benefiting from special import licenses and impose sanctions on those found in violation of the customs code. While the number of companies controlled through end-September fell slightly short of the agreed target, we will finalize the control of all companies before the end of the year.

• We will further strengthen collaboration with the customs administration of neighboring countries in the area of post-clearance control.

15. The expenditure program under the 2001 budget reflects the government's priorities for investment and social expenditure as developed in the 2001-03 MTEF. Non-interest expenditure is set to increase from 26.8 percent to 27.8 percent of GDP in 2001, reflecting additional revenue efforts and lower interest outlays. Investment expenditure (excluding Kosovo-related reconstruction) is projected to rise from 6.7 percent of GDP in 2000 to 7.5 percent of GDP in 2001, equivalent to a 17 percent increase in real terms. Expenditure on health and education is set to rise by 23 percent and 8½ percent in real terms, respectively. Regarding social assistance, in line with the World Bank's recommendations, targeting of the main program will be based on the recently completed review of the eligibility data, with expenditure in this category declining from Lek 4.8 billion in 2000 to Lek 4.6 billion in 2001, while allocations for the handicapped go up from Lek 1.8 billion to Lek 2.2 billion. The budget emphasizes improvements in the volume and efficiency of operations and maintenance expenditures, including outlays for foreign-funded projects. It also allocates an average 8½ percent nominal rise in budgetary wages and pensions as of July 1, in view of significant differentials with private sector wages and difficulties in retaining personnel—with an additional 10 percent on January 1 for military and police wages, partly offset by a decline in the Solidarity Tax earmarked for bonuses to the police force. At the same time budgetary employment will be cut by 2,200 staff by end-June and another 200 by end-October, in part through attrition, while maintaining the quality of public services. Fifty civil servants will be hired according to the new civil service law before the end of 2000—a crucial condition for the disbursement of the second tranche of the World Bank SAC. To improve the control of budget execution, as a matter of priority the Ministry of Economic Cooperation and Trade will accelerate the frequency and speed of collecting information on disbursements of foreign-financed capital expenditure and reporting these data to the Ministry of Finance.

16. We will continue developing the MTEF with assistance from the World Bank. In early 2001, we will conduct an employment survey to obtain the necessary data for assessing the appropriateness of the current level and structure of wages in the public, compared with the private sector. On that basis, we will formulate our medium-term public sector wage policies and priorities. Moreover, we will make the computerized database on all public sector employees fully functional by September 2001.

17. We will request assistance from the World Bank in designing a comprehensive reform of the pension system by end-2001, with a view to enhancing its financial sustainability. In particular, we will review contribution rates and ceilings of the social insurance system to create higher participation of the private sector. Also, we will assess the sustainability of the rural pension scheme and identify measures to reduce the large gap between contributions and benefits. Regarding immediate measures, in tandem with the approval of the 2001 budget we will amend the social security law and obligate all enterprises to file information on their payroll to the social security system on a monthly basis. The authority of inspectors in charge of collecting social security contributions will also be strengthened.

C. Monetary and Exchange Rate Policies

18. The BoA will continue to conduct monetary policy with the objective of keeping inflation low. Since three-month T-bill rates have declined to a level broadly consistent with projected inflation and the deposit rates are expected to decline further, the BoA will now focus on fine-tuning its open market operations, with a view to keeping interest rates in its primary auctions more stable. The BoA will over time, and in consultation with MAE, move to a fixed repo rate system. The central bank law will be amended by end-May 2001 so that it does not restrict BoA purchases of government paper through repo operations, thus widening its scope for open market operations through reverse repo operations. The government will convert the remaining component of its nonmarketable obligations to the BoA into marketable securities by March 2001. To broaden the T-bill market further, the BoA will consider selling small quantities of T-bills to nonbank buyers outside of the auctions. The BoA will continue to strengthen its supervisory capabilities through regular monitoring of the activities of banks and annual on-site inspections.

19. The BoA will continue to conduct its monetary operations in the context of a flexible exchange rate regime while smoothing excessive fluctuations. In its policy assessments, the BoA will take into account the balance between the lek's exchange rate against the euro—the principal determinant of external competitiveness—and that against the dollar—the main foreign currency used for financial transactions.

20. The monetary program for 2001 is consistent with a reserves-to-import ratio of about 4½ months, private sector credit growth of 32 percent, and domestic bank financing requirements of the budget deficit of 2.7 percent of GDP. Assuming that velocity remains broadly unchanged, following its decline in 1999 and 2000, reserve money growth is projected to slow down to 11 percent by end-2001, and broad money growth to about 11¾ percent. The targets for NIR, NDA of the BoA, and net credit to government for end-December 2000 and end-March 2001 have been revised to incorporate recent developments. The projected increase in private sector credit is in line with the program's objectives and, given the low base (around 4 percent of GDP) and the conservative lending policies followed by commercial banks, is not expected to cause prudential concerns.

D. Structural Policies

21. We remain committed to financial sector reform through privatizing the Savings Bank and improving the institutional framework. We have appointed a privatization advisor for the Savings Bank and are moving ahead with preparations for the privatization tender, which will be announced by end-June 2001 (structural performance criterion), postponed from end-November 2000. We will fully recapitalize the bank before the end of 2000 by issuing T-bills (prior action for completing the first review), with interest cost for the budget of 0.3 percent of GDP in 2001. We will also prepare the transfer of the bad loan portfolio to the appropriate agency by March 2001. We are currently registering the bank's real estate assets, and will perform due diligence on the bank. The law on deposit insurance is expected to be approved by parliament by March 2001 and implemented by September 2001. Following delays in establishing the credit information bureau, we have now designed a plan for setting it up with help from a foreign donor by end-2001. The registry of collateralized claims will be fully functional by December 2000. We will also be vigilant in enforcing laws preventing illegal activities by quasi-financial institutions.

22. In the area of enterprise reform, we will maintain the privatization drive of the recent months. We will conclude negotiations with potential new investors in the copper and chromium sectors, and sell the Burrel smelter and the Bulqize mine by end-2000. In the oil sector, the law on the privatization of the strategic part of Servcom was approved by parliament in early December, while the remaining smaller units will also be privatized or liquidated by the end of the year. With regard to ARMO, we have divided the company into smaller units and will proceed with preparations for the privatization of the strategic units as soon as the contract with IMI, the investment advisor for strategic projects, becomes operative again. We will also privatize seven hotels by September 2001. We will move forward with privatizing Albtelekom with a view to completing the process in the second half of 2001. The plans for a concession to build and operate the passenger terminal at Tirana airport are proceeding and tender invitations for the selection of investment consultants were issued in December.

23. Given the worsening electricity situation and its impact on the economy, we will start implementing a comprehensive package of reforms of the electricity company (KESH). Now that we have appointed new management, we have established quarterly targets for collecting bills and reducing theft and will use with determination the recently established electricity police force in achieving these targets. Meeting these targets will permit resumption of the Bank's assistance to the sector, which was suspended owing to insufficient improvement in collecting payment for electricity bills and reducing losses. We will also expedite the implementation of a number of other foreign-financed investment projects, which will expand our capacity to produce and import electricity, and will work actively with the Italian company ENEL to improve the management of KESH. We have allocated a subsidy in the budget to enable KESH to import electricity on a timely basis so as to reduce shortages in peak seasons until the proposed measures improve its financial performance.

24. We will proceed with our efforts to improve the legislative environment and to remove obstacles to efficient private economic activity. To make procedures for the approval of foreign direct investment projects more transparent and accessible, we are preparing in cooperation with donors the establishment of an investment promotion agency. We expect to send three important laws to parliament in December (the bankruptcy law; the law on mediation of business disputes, together with the necessary amendments to the civil and civil procedures code; and the law on the organization of executing court decisions in civil cases), and expect their parliamentary approval by March 2001. We will continue with the registration of land holdings despite the increasing difficulty of registering the remaining land.

25. To improve the quality and coverage of economic statistics, we are committed to further strengthening INSTAT, the central statistical agency. In the 2001 budget, we will allocate another 20 permanent staff positions to INSTAT to strengthen its capacities, including its ability to conduct the upcoming census in April 2001. Having started to publish a unit value index and a retail trade index, INSTAT intends to publish the PPI in early 2001 at which time also the weights in the CPI basket are also to be revised. Preliminary estimates of the national accounts for 1996-98 are expected to be completed by end-2000, and publication of the final accounts by mid-2001. The law on statistics, which has been drafted with assistance from the European Union, is expected to be ready for submission to parliament in early 2001.

E. External Sector Policies and Program Financing

26. With the envisaged foreign support, we expect that the balance of payments position will remain sustainable. With investment and infrastructure needs remaining large, the current account deficit is expected to remain broadly unchanged, at around 7 percent of GDP in 2001. In the medium term, the current account deficit is projected to decline as exports rise as a result of foreign investment, which would expand in response to economic and institutional reforms. Moreover, private remittances are expected to continue to grow steadily. Inflows of foreign direct investment and, primarily, concessional bilateral and multilateral support, are expected to finance the current account deficit, although small financing gaps are projected to open up in 2001 and to continue in the medium term.

27. We will continue to regularize our relations with external creditors. The government has made progress with Paris Club creditors by recently concluding bilateral agreements with Austria, France, Italy, and the Netherlands, while it has reconciled estimates of arrears to Russia. The External Debt Committee (dealing with Paris Club and non-Paris Club debt) has prepared a timetable and has formed working groups for reconciliation and rescheduling of debt in arrears. It will continue to meet on a monthly basis 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) can be removed. The government actively aims to reconcile and reschedule debt in arrears with its remaining creditors and will seek at least comparable treatment from non-Paris Club creditors with outstanding similar claims on Albania.

III. Program Monitoring and Possible Successor Arrangement

28. During the second half of the third annual PRGF arrangement, the program will be monitored based on indicative targets for end-December 2000, and quantitative performance criteria and indicative targets for end-March 2001, which have been set on a cumulative basis from end-December 1999 (Table 1). Details on the monitoring of indicative targets and quantitative performance criteria are set out in the Technical Memorandum of Understanding that accompanied the request for the third annual arrangement (Attachment I to the Memorandum dated May 25, 2000, attached to EBS/00/111). Structural performance criteria and benchmarks are set out in Table 2. 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, apart from obligations for which a rescheduling is expected.

29. In the context of our commitment toward approving and implementing a comprehensive poverty reduction strategy and the country's balance of payments needs, we intend to request a successor arrangement that could be approved immediately following the completion of the current arrangement.

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 billion was held by the Bank of Albania, Lek 104.3 billion by commercial banks, and Lek 5.6 billion 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 Lek 135.2 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 Lek 135.2 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 Lek 135.2 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 25 billion.

E. External Debt and Arrears

14. The term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property. Arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

15. The limit on 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. 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.

16. 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.

17. 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.