March 21, 2001

Dear Mr. Köhler:

        The attached Memorandum of Economic Policies describes the policies the government and the Bank of Latvia intend to follow for the remainder of 2001 and 2002. These policies are focused on ensuring that our robust economic growth is sustained, our vulnerability to external shocks remains limited, and our accession to the European Union is as rapid as possible. The program is built on a reduction in the fiscal deficit this year and next, and a return to near fiscal balance over the medium term, combined with measures to enhance the efficiency, effectiveness and transparency of the public sector. At the same time, we are continuing those structural reforms needed to ensure that Latvia reaches its full economic potential, with a particular focus on further enhancing the framework for financial services. We have also included in the attached memorandum our policies in other structural reform areas (paragraphs 32 to 38), which, while important to support sustainable growth and strengthen our market economy, are not covered by formal conditionality under the Fund program. In support of these policies, we are requesting a 20-month Stand-By Arrangement, in the amount of SDR 33 million. We do not intend to make any purchases under the Stand-By Arrangement, although we would do so should circumstances warrant.

        We believe that the policies described in the attached memorandum are adequate to meet the objectives of our economic program, but will take additional measures to meet these goals should the need arise. During the period of the arrangement, we will consult with the Fund on the adoption of any such measures that may be appropriate in accordance with the Fund’s policies on such consultations. We will conduct with the Fund two reviews of economic developments and policies under the program, the first by end-November 2001, the second by end-May 2002. In addition to a comprehensive evaluation of economic performance, the first review would focus on public sector reform and financial sector developments and oversight. The program will also be evaluated on the basis of a number of quarterly performance criteria and structural benchmarks, specified in the attached Tables 1 and 2. Performance criteria for end-March 2002 and end-June 2002 will be specified at the time of the first review, and those for end-September 2002 and at the time of the second review.

Sincerely,

Memorandum of Economic Policies

I.  Introduction

1.  Latvia has weathered the recession triggered by the Russia crisis and succeeded in restoring strong economic growth in an environment marked by low inflation and a stable exchange rate regime. Real GDP grew by about 5½ percent in 2000, driven by the strengthening of exports and investment. Growth has been broad-based, with manufacturing, forestry, and services all showing strong gains. Inflation has remained subdued, with the CPI rising by less than 2 percent in the twelve months through December. Latvia has also made strong progress in its access negotiations with the European Union (EU) closing nine of the 29 chapters to date.

2.  Latvia’s external position and outlook have improved as well. The external current account deficit fell from close to 10 percent of GDP in 1998 and 1999 to about 7 percent of GDP in 2000, despite an appreciation of the lats against the euro and the sharp rise in oil prices. Further, the share of this deficit financed by foreign direct investment (FDI) rose noticeably from just over half in 1999 to about 75 percent in 2000. This helped contain our low external debt indicators and further reduce the yield spread on Latvia’s Eurobond. Buoyant exports, especially to the EU, moderate growth in real wages, and a decline in unit labor costs, all indicate that Latvia remains competitive on international markets.

3.  Such positive developments were achieved thanks to generally appropriate macroeconomic policies and continued progress on structural reforms. The general government fiscal deficit in 2000, some 3¼ percent of GDP, represents an improvement of half a percentage point of GDP over 1999, but fell short of our objective of cutting the deficit in half. This outcome reflects both a sizable shortfall in tax revenue—owing to unexpectedly large corporate income tax repayments resulting from depressed profit levels in 1999 and difficulties in excise tax collections—as well as additional spending. As a result of these developments, we did not observe the performance criteria on the general government deficit for end-June, end-September, and end-December 2000 under the previous stand-by arrangement (SBA) with the Fund.

4.  Monetary conditions during 2000 were sufficiently tight to support the Bank of Latvia’s (BoL) exchange rate objective, and all monetary performance criteria in 2000 under the previous SBA with the Fund were observed. Reserve money and broad money grew by some 8 percent and 28 percent, respectively, during the year. Credit to the nongovernment sector grew robustly, by 37 percent, from still-low levels, deposits to the banking system rose sharply, and deposit and lending rates showed a declining trend. These developments all point to a continued deepening of financial markets and increased confidence in the banking system and the economy more generally.

5.  Financial sector developments continue to be encouraging, with key indicators improving. All banks are fully complying with the capital adequacy ratio of 10 percent, nonperforming loans are declining, and profitability is rising. Foreign investors have recently either increased or acquired majority stakes in three of the six largest banks. The BoL is fully on track in modernizing its prudential framework and is now virtually at full compliance with the Basle Core Principles for Effective Banking Supervision (BCP) and the relevant EU directives. Preparations are proceeding well to ensure that unified financial sector supervision can begin as scheduled in July 2001.

6.  We have redoubled our efforts in the structural area, with a view to creating an environment that is increasingly conducive to generating private sector activity, increasing productivity, enhancing and diversifying exports, and attracting FDI. We laid the foundation for the privatization of the Latvian Shipping Company (LASCO) and Ventspils Nafta in the first half of 2001, following selection of financial advisors and approval of the privatization guidelines for LASCO. We have also successfully implemented a wide array of measures aimed at improving the business climate, including through the simplification of permit, licensing, inspection, and registration procedures, all of which were drawn up in close consultation with foreign investors. In addition, we have harmonized our trade legislation with WTO rules and EU requirements while keeping our tariffs at or below EU levels. We have also eliminated all of our export subsidies.

II.  The Government’s Program for 2001–2002

Objectives and strategy

7.  While we remain confident that Latvia’s economic prospects are favorable, we are well aware of the important risks and challenges that face us:

• First, we fully recognize the importance of ensuring that our vulnerability to exogenous shocks—such as the Russia crisis in 1998—remains as limited as possible. In this regard, it is crucial that we continue to pursue sound macroeconomic policies, and to reign in Latvia’s still large external current account deficit.

• Second, we understand that, while our prospective accession to the EU and NATO will generate important benefits for our citizens, it will also impose substantial fiscal costs. We must take those steps now that will allow us to meet our priority spending needs while returning to a broadly balanced fiscal position over the medium-term. This will require efforts to improve the prioritization, efficiency, and management of public spending, enhance tax administration, and complete the modernization of our pension system.

• Third, we aim to complete our program of structural reform, in order to support sustainable growth and strengthen our market economy and Latvia’s capacity to weather the competitive pressures within the EU.

8.  We consider such program fully consistent with, and an integral part of, our EU accession strategy, and we are convinced that it will provide a credible framework that will enable us to meet the relevant EU criteria for membership.

Macroeconomic framework

9.  The economic program supported by the new SBA with the Fund will be based on a continuation of our successful exchange rate peg to the SDR, underpinned by tight fiscal and monetary restraint. Our macroeconomic objectives for 2001 and beyond are as follows: (i) real GDP growth of at least 5½ percent annually; (ii) inflation of no more than 3 percent per year; and (iii) a reduction in the external current account deficit to 6½ percent in 2001 and a gradual further amelioration over the medium term, with a large share of this deficit being financed by non-debt creating flows, i.e., foreign direct investment.

Fiscal policy and public sector reform

10.  Fiscal policy is the major instrument of macroeconomic management under our exchange rate regime and, as such, bears the brunt of ensuring Latvia’s continued external viability. To this end, our adopted budget for 2001 envisages a deficit of 1¾ percent of GDP, implying a fiscal adjustment of about 1½ percentage points of GDP compared to 2000. The budget calls for considerable expenditure restraint and would lower spending from 41 percent of GDP last year to 39 percent in 2001. This reduction reflects, among other things, our decision not to increase civil service wages during the current year, prudent capital spending, and the continued positive impact of the pension law amendments adopted in late 1999. Such fiscal tightening will help contain domestic demand pressures and leave sufficient resources available for robust private sector activity.

11.  We consider this deficit as a ceiling rather than a target and, to this end, will strive to proceed cautiously with our expenditure plans until we conclude, at the time of the discussion of the first review under the program with the IMF, that both fiscal and external developments are firmly on track. In addition, should external developments make it necessary, we will pass a negative supplementary budget during the second half of the year, with a view to reducing spending in non-priority areas. Finally, any central government tax revenue above those projected under the 2001 budget will be fully dedicated to further deficit reduction.

12.  We will refrain from undertaking any spending beyond the expenditure authorized in the 2001 budget and ensure that all privatization receipts, apart from those covering the administrative costs and the reserve fund of the LPA, as well as the receipts from the possible sale of UMTS and GSM licenses, are transferred to the Treasury. We will develop a medium-term plan for the best use of these additional resources, with a focus on debt reduction, the financing of pension reform and other key reforms, and infrastructure investment with high social returns. We will ensure that any spending so financed will fit within our deficit targets for 2001 and 2002 and our medium-term plan for further deficit reduction, as outlined below. In this context, we are cognizant of the importance of maintaining our external debt burden at a cautious level and will carefully assess the need for, and timing of, any further Eurobond issue in 2001 and beyond. In the same vein, to avoid taking on unwarranted fiscal risks, we will refrain from implementing the proposals to issue long-term foreign exchange swaps with involvement of the Treasury.

13.  We will aim to reduce the deficit further to near balance over the medium-term, with a deficit objective of about 1 percent of GDP in 2002. Our primary emphasis in affecting fiscal adjustment will be to better identify and further reduce less productive expenditure, making room for spending required for EU and NATO accession. To the extent possible, we will seek to lower selected tax rates, including the social tax which is high by international standards.

14.  In this context, we consider it crucial to make substantive progress in our efforts to rationalize spending. We have initiated a wide array of measures, which we will deepen over time, supported by technical assistance from the World Bank, the EU, and others. We aim, specifically, to improve our budgeting, expenditure management and procurement practices; contain the proliferation of public sector agencies and increase their accountability; enhance the transparency of public sector operations; review and modify as appropriate the functions, structure, and expenditure of ministries; implement a far-reaching civil service reform; and reduce the number of local governments.

15.  First, we are moving ahead to ensure that budget coverage is comprehensive and that budget preparation and presentation are transparent. Last year, Parliament passed amendments to the Law on Budget and Financial Management (LBFM), which is to bring all accounts of budget-financed institutions (BFIs)—those fully and partially financed directly by the budget—into the budget, require submission of annual audited reports to the Treasury from all such institutions, and vest supervisory powers in the Ministry of Finance. By end-June 2001, we will transfer all BFI accounts from commercial banks to the Treasury and ensure that new agencies open accounts only with the Treasury. By end-June 2002, we will amend the LBFM to add provisions on accounting standards and reporting guidelines for BFIs consistent with the Law on Public Agencies. When presenting our 2002 budget documents to parliament before end-September 2001, we will (i) include annexes covering contingent liabilities, tax expenditures, and quasi-fiscal activities; (ii) provide a more comprehensive presentation of forecasting assumptions and fiscal risks; and (iii) supply financing information together with an analysis of the sources of financing. These steps will broaden fiscal analysis, provide a more comprehensive picture of fiscal activity and fiscal risks to the public, and help improve the allocation of scarce budgetary resources.

16.  Second, we are taking the necessary steps to ensure that public agencies contribute to a more efficient functioning of the public sector. In March 2001, Parliament adopted the Law on Public Agencies, which defines, among other things, the functions of agencies, as well as the accounting, reporting, financial disclosure and auditing requirements for public agencies. We will adopt supporting implementation regulations by end-September 2001 to define the procedures for the formation of new agencies and for agency approval, staff remuneration issues, the determination of user charges, and financial management and accountability rules. These provisions, together with complementary legislation to be adopted to define the division of authority in the executive branch, will ensure that all agencies operate within an appropriate legal framework. Those agencies that are providing essentially commercial services will be reviewed, with a view to moving most of these activities out of the public sector. We will ascertain that all agencies comply with the requirements of the law to produce financial accounts, and such accounts will be subject to review by the State Auditor’s Office (SAO). Agencies will establish internal audit units, which will provide the assurance of the accuracy of financial accounts.

17.  Third, public procurement legislation and observation of regulations are being strengthened. A new law on public procurement has been prepared and is expected to be in place by mid-year, and implementation of this enhanced framework will be supported by the European Union.

18.  Fourth, we have completed functional and public expenditure reviews of three line ministries and begun the implementation of the derived action plans aimed at enhancing the respective ministries’ organization, increasing the efficiency and monitoring of their spending programs, and better allocating resources according to priorities. We plan to merge these reviews into comprehensive public administration reviews, which will link policy and budget planning with improvements in the management structure. To this end, we will launch, by year-end, a pilot review in at least one ministry. In addition, by end-December 2001, we will complete a government-wide institutional development plan to improve the implementation of the EU acquis communautaire.

19.  Fifth, we will strengthen our ability to develop a medium-term fiscal framework, including by placing more emphasis on our analysis of the medium-term implications of current and proposed new policies. In this context, we will draw on our public administration reviews of ministries and agencies and “zero-base” reviews of selected existing programs. We will form an interministerial budget working group which will review all proposed new policies—covering both investment and recurrent spending—and make recommendations to the Cabinet of Ministers. We will ensure that all new laws introduced by the government will be accompanied by detailed costing of their budgetary implications and will be subject to review by the Ministry of Finance before being approved by Cabinet.

20.  Sixth, we are committed to modernizing our civil service to provide an adequate level and quality of government services to our citizens. In September 2000, Parliament adopted a new Law on the Civil Service, which aims at improving the performance incentives for public servants and extending the law’s applicability to more government functions. The Cabinet of Ministers has also adopted the concept of a broad-banded, transparent, and uniform public sector wage scale, which rewards merit, minimizes discretionary and ad hoc bonuses, and allows for competitive levels of pay. To fully reap the benefits of our civil service reform, we will, by end-September 2001, adopt the implementation regulations that will allow this pay scale to become effective under a gradual implementation schedule.

21.  Finally, we will address the inefficiencies brought about by the large number of very small local governments. In line with the provisions of the Law on Administrative and Territorial Reform, 27 local governments have already undergone the amalgamation into 11 larger local governments. We intend to speed up this process further by passing the necessary changes in legislation and simplify the amalgamation process. In accordance with the Law on Administrative and Territorial Reform, we intend to complete the administrative-territorial reform of local governments by end-November 2004.

22.  On the revenue side of the budget, we will focus our efforts on a continued improvement in our tax and customs administration. We are moving ahead with our program of modernization and computerization, as well as the development of our Eastern border posts, regional offices, and taxpayer services centers, all of which will contribute greatly to our monitoring and audit effectiveness. In the same vein, a tax administration manual is being developed to reduce discretion and regional variation in application of tax laws. In addition, we will rotate our mid-level managers in both the regional and central State Revenue Service (SRS) offices so as to curtail possibilities for corruption. We will refrain from granting any new tax holidays or exemptions under the corporate income tax law beyond those granted in November 2000 for large investments; further, we will carefully monitor the financial impact of the November amendments and move to curtail their applicability, should shortfalls in corporate tax receipts endanger the achievement of our overall tax revenue objectives. Similarly, we will not expand the current number and scope of existing free economic zones and ports and will bring tax benefits to these zones and ports in line with EU regulations once legislation to this effect is passed by Parliament.

23.  Given recent shortfalls in collections of petroleum excises, we will make special efforts in this area. We will vigorously pursue our fight against smuggling and false declaration of imports, especially related to petroleum products, by stepping up our monitoring of oil transports; refusing licenses to wholesalers and retailers caught in illegal activity; increasing fines for offenders; and enhancing active monitoring of tax compliance. Nevertheless, we realize that our current system of petroleum taxation, with a wide range of rates and exemptions for the particular petroleum products in various uses, is non-transparent and facilitates such illegal practices. As a consequence, we will move to close the most damaging loopholes and, by end-June 2001, adopt amendments to the excise tax law that will (i) improve our monitoring of the existing exemptions granted to agriculture by eliminating the possibility to purchase petroleum products for such purposes in cash; (ii) require that all petroleum products which can be used for heating purposes be dyed (applying only to those products for which this is technically possible) so as to facilitate the detection of smuggling activity; and (iii) tax substitutes for, and components of, diesel fuel with the same excise duty rate as diesel fuel, provided that they are not used for heating purposes. In addition, in preparation for EU accession, we will review our excise duty rates and existing exemptions so as to bring them in line with EU requirements by the time of accession.

Pension reform and social assistance

24.  Our policies with regard to pensions will continue to aim at placing the Social Fund on a solid financial footing, while ensuring adequate retirement income, and providing proper incentives for lifetime decisions on working and saving. We intend to submit to Parliament, by end-June 2001, amendments to the pension law which, among other things, will gradually eliminate current incentives to retire early. Our objective also remains to increase the retirement age to 65 years over the medium-term. Details of these amendments will be agreed upon with the World Bank by end-April 2001.

25.  Contributions to the fully-funded pillar of our three-tier pension system will begin on July 1, 2001. Initially, 2 percentage points of the social tax rate will go to individual accounts, to be administered by the Social Insurance Agency. Over time, however, the share of the social tax dedicated to the fully-funded system will rise to 4 percent in 2007 and then gradually to 10 percent by 2010, and in 2003 private fund managers will begin to manage the pension assets. These plans make it crucial both that we strengthen the first pillar of the pension system, as described above, and that we develop regulations to ensure that the fully-funded scheme achieves its goals of increasing savings and retirement income. Such regulations will be passed by end-June 2001, governing, among other things, the management of assets and the selection and change of asset managers; the procedures for the registration and closure of individual accounts; the procedures for the calculation of the funded pension capital; and the limits on administrative expenses.

26.  We intend to improve our targeting of social assistance as a means of alleviating poverty among the poorest segments of the population, while reducing the overall cost of social assistance to the budget over the medium-term. Based on the experience gained in 2000 in some pilot municipalities, we will strive to introduce, by July 1, 2001 a national guaranteed minimum income, including a monitoring system, which will replace the current multiple social assistance programs by a unified payment. We will phase out the more poorly targeted elements of the system of social assistance.

Monetary and exchange rate policies

27.  The current exchange rate peg to the SDR has served Latvia well, and we intend to maintain this peg until accession to the EU. In support of the exchange rate peg and to meet inflation targets, the BoL will undertake foreign exchange transactions and conduct open market operations as necessary.

28.  We have formulated a quarterly monetary program, which includes performance criteria for the BoL’s net domestic assets, taking into account the expected path for growth, inflation, and balance of payments developments. The program assumes a further increase in money demand and a rise in the money multiplier, reflecting a continued rise in confidence in the economy and increased financial intermediation in our expanding banking system. Reserve money is projected to increase by about 13 percent and broad money by 27 percent in 2001. Private sector credit is expected to continue its strong growth, but to moderate during the year and in 2002, mirroring prudent lending behavior by banks. In this regard, we will continue to rigorously implement our prudential regulations and closely monitor the quality of commercial banks’ loan portfolios.

29.  The performance criteria on the floor on net international reserves (NIR) under the program were derived on the basis of the need for an adequate level of international reserves. This floor has been set at a level that is lower than projected under the monetary program, given the difficulties in accurately predicting capital flows. While we view the issuance of long-term (two-year) swaps as having played a role in developing longer-term lending in lats, we believe that the private sector is now ready to undertake this role. In this context, we intend to reduce the monthly auction volume by half, to LVL 5 million in April 2001, and decide on their full elimination by the time of the first review under the program. In the event of pressures in the foreign exchange market, the BoL will take the necessary measures to defend the peg, including by raising interest rates. We will consult with Fund staff in case of interventions in the foreign exchange market exceeding US$75 million in any two-week period.

Financial sector policies

30.  Building on the excellent progress to date, the BoL will complete its endeavor to ensure full compliance with the Basle Core Principles for Effective Banking Supervision (BCP) and the relevant EU directives by July 1, 2001, the date when the banking supervision function will be transferred to the new Financial and Capital Markets Commission (FCMC), the unified financial sector supervisory agency. Specifically, by end-September 2001, we will submit to parliament amendments to the Law on Credit Institutions (LCI) to enable the FCMC to prohibit the establishment or continuation of close links with domestic and overseas third parties (including affiliated companies), as well as transactions with such parties, provided that such links and transactions are viewed to endanger the soundness and the safety of the bank or hinder the FCMC in effecting its supervisory functions. We envisage that these amendments will be passed by Parliament by end-March 2002. We aim to rewrite the LCI and finalize a draft for submission to Parliament by end-2002 so as to make it less subject to revisions than in the past, and delegate some of the law’s current technical provisions to regulation, in line with international practice.

31.  We are on track in establishing the organizational and institutional structure of the FCMC so as to ensure a smooth transition in unifying banking sector regulation with that for securities, insurance, and pension funds. A strategic plan is being implemented, which outlines measures to achieve operational efficiency and a smooth integration of supervisory functions, and which will be instrumental in ensuring that the relevant international supervision standards are being met. We are fully committed to ensuring adequate safeguards to maintain the political and operational independence of the new regulatory agency, and a high quality of staff.

Privatization and other structural reforms

32.  The structural reform component of our economic program will focus on pursuing the privatization of our large-scale enterprises, creating a competitive framework for our energy and telecommunications sectors, and continuing our efforts to enhance the business climate, including by improving governance. Progress in these areas will lay the foundation for robust and sustainable economic growth in Latvia and make Latvia an attractive place for foreign investors in the years to come.

33.  The privatization of small and medium-sized enterprises in Latvia is complete, and we are moving to privatize several of the remaining large public enterprises during 2001. Our emphasis is on implementing a transparent process that will bring the largest possible benefit to the Latvian economy and, toward this end, we have hired international advisors to help us develop privatization plans for each of the remaining large enterprises. Following the advice of one such advisor, we intend to complete the sale of 68 percent of the Latvian Shipping Company (LASCO) to a strategic investor by end-September 2001. We have agreed that Transparency International will be monitoring this privatization process. We expect to dispose of the government’s remaining stake of 38 percent in Ventspils Nafta by end-2001. While we aim to complete the privatization of Lattelekom as quickly as possible, further action must await the outcome of arbitration proceedings related to the WTO-mandated relinquishing of the company’s monopoly rights in 2003.

34.  Improvements in the regulatory and legal framework for all utilities need to move forward in parallel with the privatization process. We will strive to put in place, by end-September 2001, a single regulatory agency (superregulator) with responsibility for all public utilities, comprising telecommunications, post, railway transportation, and the energy industry (except district heating, where electricity is not generated in the production process). In this regard, Parliament has already passed the Law on Regulators of Public Services, and necessary secondary legislation will be passed before the new regulatory agency begins operations. While the passage of a new telecommunications law has been put on hold until an agreement has been reached in the Lattelekom case, we are taking some interim steps to improve regulation and enhance competition in this area. Specifically, by end-September 2001, regulation of the telecommunications sector will be integrated with the superregulator, initially operating under the existing telecommunications law and an umbrella agreement. In addition, by end-June 2001, we will enact supporting legislation defining (i) the services to be regulated by the superregulator or deregulated, and (ii) rules for licensing. A clear segregation of responsibilities between the regulator and ministries is defined in the Law on Regulators of Public Services as well as sector-specific legislation.

35.  We are committed to improving competition in the energy sector and, in that context, we intend to complete by end-December 2002 the restructuring program for Latvenergo, adopted by the Cabinet of Ministers in October 2000. The restructuring plan envisages the establishment of separate units and accounting systems for all arms of the company—distribution, transmission, and power generation. In addition, we have begun implementing a new grid code, which provides third parties access to energy transmission and distribution and establishes separate transmission and distribution service prices. We have decreased the criteria for qualified customers from 100 GWH to 40 GWH to increase the number of possible market participants. We will continue to review transmission and distribution tariffs to ensure competitive and market-based pricing.

36.  We will continue to improve the business environment in Latvia, notably by implementing the requirements of the acquis communautaire and the action plan for improving the business environment adopted by the Cabinet of Ministers—based on the recommendations of the 1999 Foreign Investor Advisory Service (FIAS) report on administrative barriers to foreign investment. We are making good progress in implementing these measures. For example, the visa and work permit regulation has been simplified; the real estate tax has been reduced to a flat 1 percent; customs procedures are now more transparent; regulations on the various inspections have been harmonized and written reports are now available to the inspected enterprise; the process of obtaining construction permits has been simplified; and a unified enterprise registration procedure has been put in place. We will work closely with municipalities to ensure that the simplified rules for obtaining construction permits are being applied, including the fee schedule. Following our action plan, we will enact new legislation on land transactions by end-2001, which will gradually remove the remaining barriers for land purchases by foreign investors. We will continue our efforts to strengthen the capacity of the judicial apparatus and increase judicial training. Other future key measures will include (i) setting up the Customs Advisory Service and introducing a national help line by September 2001 to simplify customs procedures and ensure transparency; and (ii) further streamlining overland border crossing procedures with neighboring countries, particularly Russia.

37.  We have continued to make good progress in land registration and apartment privatization. By end-December 2000, nearly all land properties had been registered in the cadastre and some 50 percent had been entered into the Land Book. In addition, we have offered for privatization some 90 percent of the government-owned apartments, of which some two-thirds have been sold by end-December 2000.

38.  In our view, the efforts mentioned above to simplify and make more transparent the government’s role in the economy will have an important positive impact on governance, by limiting the scope for administrative corruption. We are also committed to undertaking our policy and institutional reforms to improve governance, under the leadership of the Corruption Prevention Council and in coordination with the World Bank. In this regard, we are strengthening our efforts to limit conflict of interest for public officials. To this end, the Anticorruption Unit (AU) of the SRS is preparing an action plan for the development of (i) a system of conflict of interest; (ii) adequate reporting forms for public officials for disclosure of income and assets and conflict of interest; (iii) a comprehensive list of public officials to be subjected to the disclosure requirements; and (iv) a draft manual and curriculum for training of SRS staff in processing and assessing declarations.

Trade policy

39,  Latvia maintains a very liberal trade system. During the last four years, we have reduced the simple average MFN tariff from 5.6 percent to 4.6 percent, and we will eliminate the current MFN rate of 0.5 percent applied to some industrial goods by January 2002. We will ensure that our trade legislation will continue to be in line with EU requirements and follow WTO rules and agreements, and to this end, among other things, reduce our tariffs on agricultural commodities. We intend to keep our tariffs at or below EU levels. Further, we shall neither increase any ad valorem tariffs nor introduce any new specific tariffs or export subsidies.

Epilogue

40.  We believe that the policies described above will help ensure that Latvia experiences strong and sustainable economic growth over the medium-term. We stand ready to take additional measures to meet these goals should such a need arise.

Performance Criteria on General Government Fiscal Deficit and Indicative Targets on Central Government Tax Revenue

The general government is defined to include the central government basic and special budgets and the local governments basic and special budgets. The general government fiscal deficit is defined as the increase in net claims on the general government of the domestic banking system comprising the Bank of Latvia and licensed commercial banks; plus the net increase in all other claims on the general government of domestic and foreign financial and nonfinancial institutions or households; plus the privatization receipts net of the legally stipulated administrative expenditures and allocations to the reserve fund of the Latvian Privatization Agency (LPA). Upon closure of the LPA, the privatization receipts will accrue to the Ministry of Economy and, as is currently the case under the LPA, be transferred to the treasury.

The net claims of the domestic banking system on the general government are defined as all claims of the Bank of Latvia and licensed commercial banks on the general government, less all deposits of the general government with these institutions. The claims of the banking system on the general government include, but are not limited to: bank loans (including overdrafts) to the general government and securities issued by the general government held by banks. Deposits of the general government with banks include domestic or foreign currency deposits.

The ceilings on the general government fiscal deficit will be adjusted downward by the extent to which central government tax revenues exceed the respective indicative targets outlined above. The taxes to be included in this calculation are: (i) the corporate income tax; (ii) the value added tax (VAT); (iii) all excises; (iv) customs duties; (v) the personal income tax accruing to the central government special budgets; (vi) central government taxes in transit; and (vii) the social tax.

Monthly data on net claims of the domestic banking system on the general government are taken from the balance sheet of the Bank of Latvia and the consolidated balance sheet of all licensed commercial banks. The Bank of Latvia will also provide separate information on the deposits of the LPA with the domestic banking system, as long as the LPA is excluded from the definition of government applied in the monetary statistics. The treasury will record receiptsfrom foreigners from privatization and the sale of UMTS and GSM licenses in a separate subaccount in the treasury system and report the monthly balance of such subaccount to both the Bank of Latvia and the IMF. In addition to providing the monthly Treasury Report showing all general government revenue and expenditure by economic classification, the Ministry of Finance shall provide information on: (i) net sales of all Latvian State Treasury securities and any other general government debt instruments; (ii) other general government net borrowing; (iii) net changes in general government deposits held abroad; (iv) disbursements and repayments related to foreign loans extended to the general government; (v) gross receipts from foreigners from privatization and the sale of UMTS and GSM licenses and the uses of such receipts, as well as information on the LPA’s deposits with the banking system; (vi) net lending operations of the general government; and (vii) the receipt and use of foreign grants, including from the European Union. All such information is to be provided monthly to the IMF by electronic means and in hardcopy by the 17^th day of the following month. In addition, the official quarterly debt tables should be provided to the IMF by electronic means and in hardcopy within two months following the end of the quarter in question.

If any data taken from the above sources are subsequently revised due to errors, omissions, or any other reasons, the IMF will be notified, without any delays, of such revisions.

Net Domestic Assets of the Bank of Latvia and the Banking System

Net domestic assets of the Bank of Latvia are defined as the difference between: (i) reserve money, i.e., the issuance of lats plus deposits of commercial banks with the Bank of Latvia (including obligatory reserves but excluding banks’ term deposits with the Bank of Latvia); and (ii) the Bank of Latvia's net international reserves (as defined in Annex III). Net domestic assets of the Bank of Latvia would thus include: net credit to the general government; credit to commercial banks; and other net assets. Both (i) and (ii) will be expressed in lats.

The ceilings on net domestic assets are established on the basis of an assumption of (i) disbursements in balance of payments assistance of $0 million in the first quarter of 2001, $0 million in the second quarter of 2001, $40 million in the third quarter of 2001, and $0 million in the fourth quarter of 2001; and (ii) zero receipts from foreigners from privatization and the sale of UMTS and GSM licenses. The ceilings were derived from the Bank of Latvia balance sheet by assuming an underlying increase in foreign exchange swaps of $15 million per quarter; the stock of such swaps amounted to $184 million at end-December 2000. The ceilings on net domestic assets (both at the Bank of Latvia and banking system levels) will be adjusted upward (downward) for any shortfall (excess) in disbursements from foreign creditors of balance of payments assistance relative to the programmed levels. The ceilings on net domestic assets will also be adjusted downward for any receipts from foreigners from privatization and the sale of UMTS and GSM licenses, which remain in the subaccount of the Treasury established for such purpose (see Annex I). The ceilings will be adjusted downward (upward) for any accumulation (decumulation) of foreign exchange swaps compared to the stock of such swaps at end-December 2000. The limits indicated in the table below are stock numbers for the respective date and will be monitored monthly based on the balance sheet of the Bank of Latvia. The balance sheet at the program exchange rate and at the actual exchange rate is to be provided monthly by the Bank of Latvia to the IMF by electronic means and in hardcopy by the 17^th day of the following month.

Net Domestic Assets of the Bank of Latvia

Net domestic assets of the banking system are defined as the difference between the liabilities of the banking system to the nonbank public (M2X) and net foreign assets of the banking system. Net foreign assets of the banking system are the sum of all gross claims on nonresidents, less liabilities to nonresidents (excluding foreign equity). Thus, net domestic assets of the banking system include: net credit to the general government; gross credit to the nongovernment sector; and other net assets (including foreign equity).

The indicative limits shown in the table below are stock numbers and will be monitored monthly from the consolidated balance sheets of the banking system. The balance sheet at the program exchange rate and at the actual exchange rate is to be provided monthly by the Bank of Latvia to the IMF by electronic means and in hardcopy by the 17^th day of the following month.

If any data taken from the above source are subsequently revised due to errors, omissions, or any other reasons, the IMF will be notified, without any delays, of such revisions.

Net Domestic Assets of the Banking System

Target for the Convertible Net International Reserves of the Bank of Latvia

Convertible net international reserves of the Bank of Latvia consist of gross international reserves less foreign liabilities in all convertible currencies, both expressed in U.S. dollars.

For purposes of the program, gross international reserves will comprise all liquid foreign assets of the Bank of Latvia which are readily available, including monetary gold, holdings of SDRs, any reserve position in the Fund, holdings of foreign exchange, and any deposits with nonresident financial institutions. For purposes of the program, foreign liabilities will be defined as use of Fund credit, and on balance sheet foreign currency liabilities of the Bank of Latvia.

For the entire period of the program, the exchange rates of the SDR and other currencies vis-à-vis the U.S. dollar will be those prevailing at end-December 2000.

The performance criteria on the floor on net international reserves of the Bank of Latvia are specified below. The floor on net international reserves is established on the basis of an assumption of (i) disbursements in balance of payments assistance of $0 million in the first quarter of 2001, $0 million in the second quarter of 2001, $40 million in the third quarter of 2001, and $0 million in the fourth quarter of 2001; and (ii) zero receipts from foreigners from privatization and the sale of UMTS and GSM licenses. The net international reserves floor was derived from the Bank of Latvia balance sheet by assuming an underlying increase in foreign exchange swaps of $15 million per quarter; the stock of such swaps amounted to $184 million at end-December 2000. The net international reserves floor will be adjusted downward (upward) for any shortfall (excess) in disbursements from foreign creditors of balance of payments assistance relative to the programmed levels. Likewise, the floor of international reserves will be adjusted upward for any receipts from foreigners from privatization and the sale of UMTS and GSM licenses, which remain in the subaccount of the Treasury established for such purpose (see Annex I). The net international reserves floor will be adjusted upward (downward) for any accumulation (decumulation) of foreign exchange swaps compared to the stock of such swaps at end-December 2000. The stock of net international reserves of the Bank of Latvia, as well as the stock of all outstanding swap operations, are to be provided monthly by the Bank of Latvia to the IMF by electronic means and in hardcopy by the 17^th day of the following month.

If any data taken from the above source are subsequently revised due to errors, omissions, or any other reasons, the IMF will be notified, without any delays, of such revisions.

Net international Reserves of the Bank of Latvia

External Debt

1/ Concessional borrowing refers to loans with a grant element of at least 35 percent discounted on the basis of the OECD Commercial Reference Interest Rates (CIRRs).

2/ The performance criteria on debt ceilings apply not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85) adopted August 24, 2000), but also to commitments contracted or guaranteed for which value has not been received. Temporary exchanges of assets, such as swaps and lease arrangements with non-residents, are included under this definition of external debt. Because of difficulties in ensuring effective monitoring of leasing by local entities, such transactions by local governments are excluded from the external debt limits.

External debt limits apply to external debt—with original maturities of up to and including one year; to nonconcessional medium- and long-term external debt of original maturities of more than one year; and to commitments contracted or guaranteed for which value has not been received. For the purpose of the program, the so defined external debt limits apply to debt contracted or guaranteed after December 31, 2000 by the government, the Bank of Latvia, or any other agencies on behalf of the government, with sub-ceilings for such debt of maturities of more than one year up to and including five years. The definition of the government is the same as in Annex I. The stock of medium- and long-term debt was $648.4 million as of December 31, 2000. For the purpose of measuring the performance criteria on short-term external debt with a maturity of up to and including one year, the outstanding stock of this debt, which excludes normal import-related trade credits, was zero at December 31, 2000. Excluded from the limits are the use of Fund resources; but other balance of payments support would be covered by these limits, including loans from official creditors and foreign banks. Contracted loans shall be valued in the currency of transactions and converted into U.S. dollars at the exchange rate prevailing at the time the loan is contracted.

Compliance with the limits shall be verified at quarterly intervals for the dates shown above. Information on the contracting and guaranteeing of external debt, as well as the outstanding stock of government debt, will be reported monthly to the IMF by electronic means and in hardcopy by the Ministry of Finance by the 17^th day of the following month. In addition, the official quarterly debt tables should be provided to the IMF by electronic means and in hardcopy within two months following the end of the quarter in question.

In addition to the performance criteria specified above, a continuous performance criterion respecting the nonaccumulation of external payments arrears by the government applies.

If any data taken from the above source are subsequently revised due to errors, omissions, or any other reasons, the IMF will be notified, without any delays, of such revisions.