December 8, 1998

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington D.C. 20431

Dear Mr. Camdessus:

Following the presidential elections and the change in administration early this year, we decided to review the approach the government had intended to pursue in some key areas, such as the energy sector, while continuing with the implementation of our macroeconomic stabilization strategy and deepening our reform efforts in privatization and bank restructuring. Conducting such a review proved more protracted than anticipated, and as a result there was a delay in formulating the third annual ESAF program. In hindsight, we feel this interlude has been beneficial to us. We believe there is now a better understanding of the rationale for the policies envisaged in the program, their sequencing, and the importance of their timely implementation.

More generally, having achieved a reasonable degree of macroeconomic stability in 1998, we feel it appropriate to shift our efforts toward revitalizing reforms in areas that would support sustained economic growth over the medium term, including public sector management, private sector development, deepening of financial markets, financial rehabilitation of the energy sector, and civil service reform. Unfortunately, a good part of our efforts will have to be devoted to weathering the impact of the deterioration in external conditions which we have been experiencing since late August.

In the accompanying document, we have outlined our economic program for the period October 1, 1998 to September 30, 1999, which should help us both in cushioning the impact of the adverse external environment, and in setting a solid base for achieving our medium-term goals. For the remainder of 1998, we are determined to achieve the overall targets of the program formulated early this year. To this end, we have taken appropriate fiscal measures and will continue to pursue a tight credit policy in the context of a flexible exchange rate policy. The cornerstone of our program for 1999 is the draft budget which was recently submitted to parliament. The firm implementation of this budget will be instrumental in controlling the growth of aggregate demand together with the other supporting policies that are also developed in this document. In addition, our medium-term reform program for 1998-2001 is described in our Policy Framework Paper which we have forwarded to you under separate cover. If necessary, we are prepared to take further measures to ensure the success of our program, after consulting with the Fund.

In support of these policies, the government of Armenia hereby requests a third year arrangement under the ESAF in an amount equivalent to SDR 33.75 million. Moreover, the three year commitment period under our ESAF arrangement is due to expire on February 13, 1999. We request that the commitment period be extended to permit adequate time for the second disbursement under the arrangement to be made.

Sincerely yours,

2.  These favorable trends have changed since late August-early September as we began experiencing the spill-over effects of the crisis in Russia. Exports to Russia, which accounted for over one fourth of total exports, have declined; workers remittances and private transfers from Russia, which had amounted to almost $5 million a month in the first half of 1998, have fallen sharply; there has been a noticeable reduction in the presence of nonresidents in our treasury bill market; and foreign direct and portfolio investments, including the sale of some corporations to Russian investors, have been postponed. The initial impact on the exchange market has been mitigated through a combination of rising domestic interest rates, some nominal depreciation of the exchange rate coupled with moderate official intervention, and a continued tightening of financial policies. Since late August the dram has depreciated by about 3 percent against the U.S. dollar and interest rates have risen to over 40 percent despite our deliberate decision to restrain domestic borrowing by the state. Monetary management has become more complicated since early September, and as a result we have experienced some loss in net international reserves.

3.  Throughout the first three quarters of 1998 we have maintained a reasonable degree of monetary restraint aided by prudent fiscal management. Following a sharp contraction in the first quarter of 1998, reserve money started growing steadily thereafter, reaching its end-1997 level only by end-September. Reserve money growth has been driven by a slow but sustained expansion of net credit to the government, as the government monetized the profits from the CBA. The deficit of the state budget (comprising the republican and the local governments) rose from 1 percent of GDP in the first quarter of 1998 to 4¾ percent of GDP in the first nine months of the year, in line with the annual target of 5½ percent. Revenues continued to perform strongly in the first nine months of the year, particularly nontax revenue, and expenditures remained below projections, mainly because of lower capital expenditures. The financing of the deficit has become more expensive since early September and this, combined with some shortfalls in external financing and grants, has forced us to reconsider our expenditure plans for the remainder of the year.

4.  The privatization of state-owned enterprises has been very successful, particularly through international tenders; by late August the sale agreements already concluded, or in the process of being settled, amounted to $115 million (or about 6 percent of GDP). On civil service reform, however, we have been unable to meet our targets to reduce budgetary employment, as we decided to develop first a concept of civil service reform and proceed with our employment retrenchment program in that context. To this end, we have prepared a draft Civil Service Law that has been submitted for comments to various multilateral institutions and government agencies. We have also established a Working Group on Civil Service Reform, which is in charge of developing an action plan and timetable for its implementation with the assistance of the World Bank. We have also experienced some delays in forming a consensus on the steps required to implement the reform of the pension system, and have faced some technical difficulties in introducing individual social security/taxpayer identification numbers.

5.  The implementation of the financial rehabilitation of the energy sector formulated in December 1997 in consultation with the staffs of Fund and the World Bank was delayed in order to consider an alternative strategy that would emphasize efficiency gains rather than tariff increases. We are now satisfied with the course taken. We have gained greater insight into the consolidated financial position of the sector, identified its financial gaps, and the role to be played by cost reducing measures, debt workouts, and price increases. During the summer of 1998, we contracted a group of external advisors to evaluate the proposed measures to increase revenue collection rates and to reduce technical as well as nontechnical losses. As a result, a grant of $15 million from USAID has been reallocated from budgetary support to the energy sector for the purchase of meters. We are persuaded now that future tariff increases will play a better role in helping to address the still considerable financial gaps. In this new framework, we have created a joint-stock company with RAO Gazprom and Itera. Armenia’s participation in the capital of this company comprises the gas storage and distribution system (valued at $270 million). RAO Gazprom and Itera will acquire up to 55 percent of the capital (about $150 million) in exchange for supplying gas for an equivalent amount during the period 1998-2001. While acknowledging that the cost of rethinking our strategy in this critical sector caused serious delays in arranging our external financing package for 1998, particularly with the World Bank, we are confident that the revised strategy will help us achieve our goals.

7.  To close the above mentioned gap, we have submitted to parliament a request for authorization to use additional privatization proceeds for about 0.6 percent of GDP, and expect to conclude negotiations with the World Bank on a SACIII loan of $50 million, including an upfront disbursement of about $10 million, or about 0.5 percent of GDP. In addition, we have decided: (i) to step up our tax administration efforts, particularly in liquidating assets confiscated as part of nontax payment rulings with an approximate yield of about 0.6 percent of GDP; and (ii) to limit expenditure authorizations in October and November in line with an annual expenditure plan that is 1.3 percent of GDP lower than in the 1998 budget.¹ On this basis, the revised deficit target for 1998 would be dram 50 billion or 5¼ percent of GDP, excluding privatization proceeds of about 2 percent of GDP, which compares to the original program target of dram 64 billion, or 7 percent of GDP, excluding privatization proceeds of 1½ percent of GDP.

8.  The monetary program has been tightened to contain the inflationary and exchange rate pressures that have emerged because of some reduction in dram deposits and a declining presence of nonresidents in the treasury bill market which has occurred notwithstanding a large increase in interest rates. The CBA has been responding to pressures in the foreign exchange market, or deviations from the inflation and money targets, with limited intervention in the foreign exchange market, by placing greater reliance on changes in credit extended by the CBA to the commercial banks and by closely coordinating the financing of the budget by the treasury with the management of liquidity in the financial system. As a result, reserve money is expected to grow only moderately in the last part of 1998, while a smaller decline in net international reserves is expected. We are targeting gross official international reserves to be no less than the equivalent of 3.6 months of imports of goods and nonfactor services.

9.  With regard to the management of our nonconcessional external debt, we expect to conclude a restructuring agreement with the EU during this year. Since the net payment being requested was not budgeted for in 1998, we have submitted to parliament a request for authorization to use additional resources from the Privatization Account for the equivalent of dram 5.5 billion (about $10 million). This additional appropriation, together with the dram 3.4 billion (about $7 million) earmarked to prepay external debt in the 1998 budget, would help us settle this long standing issue.

11.  To achieve these targets, we will limit the state budget deficit (comprising the republican and local governments) to dram 61 billion (or 5½ percent of projected GDP) excluding privatization proceeds of 1 percent of GDP.² The financing of the state budget deficit will comprise 1¼ percent of GDP from domestic sources, and 4¼ percent of GDP in the form of net foreign credits from multilateral and bilateral creditors. We have reached understandings with the IMF staff that the draft budget submitted to parliament on November 2, 1998, is consistent with the availability of domestic and external resources that have been secured so far, and is in line with achieving the above mentioned fiscal targets. However, we would like to stress that the draft 1999 budget falls short of broadening the coverage of our social expenditure targets to protect the most vulnerable groups of society. For this reason, we have included an appendix to the draft budget that contains social safety net, maintenance and capital expenditures for dram 9.6 billion (about $17 million) or 0.9 percent of GDP, which would be executed only if additional concessional resources are secured, or if we can identify and implement additional fiscal measures. Priority in executing these additional expenditures would be given to social safety net spending.

12.  As indicated above, and against a background of changing foreign investors’ sentiment toward emerging markets, the use of privatization proceeds for budget support in 1999 will be limited to 1 percent of GDP. Any privatization proceeds over and above the amount envisaged to be used in the draft 1999 budget would be held in the Privatization Account at the CBA, until a comprehensive strategy has been designed to ensure the most efficient allocation of these funds, including the possibility of improving Armenia’s external debt and debt service profile over the medium term. The interest earned on the Privatization Account will be capitalized until the mid-term review under the third year arrangement. At that time, the use of interest earnings on the special account for budgetary support will be re-examined in the context of the overall strategy on the use of privatization proceeds being developed with the assistance of the World Bank and the Fund. According to the above policy, the government will establish limits for the quarterly use of privatization proceeds for budgetary support for the remainder of the year and 1999, in line with the understandings in the Technical Annex.

13.  We envisage that tax revenue collections at the state level in 1999 are likely to reach 15¼ percent of GDP, as high as in 1998. To offset the revenue impact of the projected slowdown in economic activity, particularly from those sectors most severely affected by the Russian crisis, we have implemented: (i) revenue measures with an approximate yield of dram 9 billion (about 0.9 percent of GDP), arising in large part from an increase in the excise on cigarettes, new environmental taxation, increase in import tariffs on plastics and paper, and fees for replacing car license plates and drivers’ licenses; and (ii) tax administration measures with a yield of approximately dram 4 billion (about 0.4 percent of GDP), reflecting a switch to indirect methods of assessing the VAT, and a more expeditious liquidation of confiscated assets from delinquent tax payers, through the use of a Committee of Judicial Executors.

14.  Total expenditures (including net lending) will be limited to 24¼ percent of projected GDP in 1999, marginally lower than in 1998. The overall wage bill of budgetary organizations has been targeted to rise slightly less that nominal GDP, but we expect real wages to increase in the context of a civil service retrenchment program which is described below. Recognizing the importance of social programs to protect the most vulnerable groups in society from the effects of the Russian crisis, especially due to a decline in workers remittances and private transfers, spending on social safety net programs will increase in real terms, as will expenditures in the health and education sectors. In line with our commitments under the World Bank SAC III loan currently under negotiation, we have allocated 22½ percent of current expenditures of the state budget in 1999 to health and education. Family allowances and unemployment benefits will be better targeted. The retirement age will be increased gradually as called for in the Pension Law. Domestically financed capital spending is expected to fall by 0.6 percentage points of GDP reflecting the priority given to social spending. We also intend to maintain our policy of not issuing guarantees on domestic borrowing by state enterprises, and have made provisions against outstanding contingent liabilities within the general contingency fund in the budget. In order to avoid the emergence of arrears, we have reformed the expenditure authorization process and we will continue to implement the scheme developed in consultation with the IMF staff, that allows for the monitoring of authorizations and payments of core expenditures in the budget. Steps will also be taken to monitor the operations of existing extrabudgetary funds with a view to reduce their number by the year 2000.

15.  The government remains committed to improve the system of tax administration. To this end, steps will be taken to: (i) detect quickly non-filers and late payers; (ii) identify traders still unregistered and without tax identification numbers; (iii) ensure that the large tax payer unit is fully operational; and (iv) provide the State Tax Service with a modern organization structure and information technology. In addition, the High Level Committee (HLC), which is headed by the prime minister, will continue to implement the strategy developed in consultation with the IMF staff in 1998. The HLC will conclude resolving the situation of the 60 largest tax debtors in the first half of 1999, including initiating bankruptcy procedures, litigation, confiscation of assets, or any other action conducive to collecting overdue tax liabilities.

16.  The target of containing inflation to single digit levels amidst a climate of uncertainty created by the adverse external environment, will require a sustained tightening of the growth of monetary and credit aggregates during 1999. Reserve money is targeted to grow at 9¼ percent during the year, while the expansion in the net domestic assets of the CBA relative to the stock of reserve money at the beginning of the year is targeted at 11½ percent. The CBA remains committed to the policy of not extending net credit to the government on a quarterly basis. The financing of the government’s intra-quarter borrowing requirements will rely increasingly on the placement of treasury bills, although during 1999, we envisage that there will be some need for CBA direct intra-quarter lending. The CBA may also provide some limited liquidity support to the secondary market for treasury bills, if needed. Given the projected rise in the multiplier associated with a small decline in the demand for currency, dram broad money is expected to grow by 15¼ percent, and net official international reserves are expected to decline marginally during 1999. As the external environment stabilizes, inflationary pressures are brought under control, and the slowdown in growth is overcome, dram broad money velocity is expected to decline.

17.  The CBA will respond to deviations in the broad monetary aggregates or inflation targets by controlling overall credit using market-based indirect instruments and/or by allowing the exchange rate to reflect underlying market conditions. Net official intervention in the foreign exchange market will be limited to the smoothing of exchange rate fluctuations. To this end, monetary operations will be guided by an indicative path for reserve money, especially when dealing with upward pressures on the exchange rate. To ensure a timely response to unanticipated capital inflows, the CBA has established, on an experimental basis, a continuous upper limit on the within-quarter deviations in the indicative stock of reserve money. If at any point in time within the quarter, reserve money reaches the upper limit, the CBA will undertake corrective actions, either by increasing the size of open market operations, or by allowing the exchange rate to appreciate. In contrast, policy responses to downward pressures on the exchange rate will continue to be guided by the established floor on net international reserves, which continues to be a performance criterion under the program. Profit transfers from the CBA to the budget, if any, will be done in a way that does not affect the implementation of the monetary program and only after appropriate verification by an external auditor that such a transfer will not affect the financial integrity of the CBA. In line with this monetary program the government will observe the quarterly limits that have been placed on NDA and NIR of the CBA, and the net credit to the government from the banking system as given in Table 1 for end-December 1998, and end-March, June, and September 1999.

18.  The government’s objective to reduce the external current account deficit (excluding official transfers) to about 22 percent of GDP in 1999, hinges on setting the appropriate conditions to promote a faster growth of net exports despite expected continued adverse external conditions in at least the first half of 1999. To the extent that pressures on the external sector related to the Russian crisis persist, the government intends to maintain a tight rein in the growth of aggregate demand supported by the pursuit of a flexible exchange rate policy. We do not intend to impose restrictions on either trade or capital movements and we will continue to resist pressures to raise tariffs from their present levels of 0 and 10 percent. We will also endeavor to complete all necessary steps to seek an early accession to the WTO in 1999.

19.  With regard to external debt, we will continue to pursue a very cautious approach concerning nonconcessional external borrowing. At this time we do not envisage any prospective nonconcessional lending or guaranteeing operations in the rest of 1998 and in 1999. Accordingly, we have reached understandings with the IMF staff that the program limit on the contracting and guaranteeing of nonconcessional external debt should remain at its end-September 1998 level for the program period. It is understood, however, that the adequacy of this limit will be a subject of the mid-term review under the ESAF program. Meanwhile, the government will seek to develop a policy for extending sovereign guarantees and the technical capacity to evaluate which investment projects should be eligible. Assuming that the borrowing limit is kept unchanged for all of 1999, the net present value (NPV) of Armenia’s public and publicly guaranteed debt would decline to 31½ percent of GDP at end-1999, from about 34 percent at end-1998. The ratio of the NPV of public and publicly guaranteed debt to exports of goods and nonfactor services would reach 150 percent at end-1999, compared to 170 percent in the preceding year, and the NPV ratio to government revenues would reach 183 percent at end-1999, down from 199 percent at end-1998. The government would consider using privatization proceeds over and above the limit in the budget to improve the medium-term profile of external debt service. In addition, we will continue our efforts at strengthening further the monitoring of debt. We are seeking donor support to expedite the installation of a computerized debt management system, and are taking steps to enhance further the management, accountability and public dissemination of official information on official transfers and loans in kind.

20.  On structural reforms, the government will make efforts to accelerate the momentum in the privatization process. The implementation of the international tender program will proceed uninterrupted. Regarding medium-sized enterprises, the government will offer for sale all remaining flour mills and bakeries in the first half of December 1998, and will initiate liquidation procedures for those which cannot be sold for the third time. All other enterprises will be privatized according to the timetable agreed with the World Bank and in line with the Privatization Program adopted by parliament at the end of 1997. Regarding those enterprises that will remain in the public sector, the government will develop in 1998 a system to monitor their financial operations, including any use of budgetary resources. Implementation of this system will start in the first quarter of 1999.

21.  The government’s policies in the banking sector will aim at consolidating the overall soundness of the commercial banks and strengthening further the supervision and regulatory framework. We place particular emphasis on: (i) strengthening the banks’ capital adequacy, as evidenced by our recent decision to raise current requirements to 12 percent for general capital and to set the minimum ratio of core capital to risk-weighted assets at 8 percent, with higher standards for new banks; (ii) reducing the banks’ exposure to foreign exchange risk, as signaled by our recent decision to reduce the symmetric limits on banks’ open foreign exchange positions in relation to capital; and (iii) implementing loan classification guidelines that would facilitate a sound assessment of the quality of banks’ portfolios. While the supervisory and regulatory framework is still evolving the government does not intend to introduce a deposit insurance scheme. However, we will continue our efforts to restructure the banking system and clearly delineate the role of the public sector in the financial system. In this connection, the government will seek to reduce its share holdings in Ardshinbank to no more than 14 percent of capital in December 1998. This is expected to be achieved through a public auction of shares, a public offering to raise capital, or by using any other mechanism available. The government will liquidate its remaining share holdings in this bank by end-June 1999. We will also remove all government officials from the Boards and Councils of all commercial banks except for the Savings Bank. With regard to the latter, the government will refrain from initiating the overall restructuring/privatization of the Savings Bank until a well-considered strategic plan has been developed by mid-1999. The plan will address the issue of the savings deposits accumulated in the Savings Bank during Soviet times and adopt the best modality for its eventual privatization. In developing this plan, the government will seek assistance from the World Bank and the IMF, as well as from investment banks.

22.  We also intend to take measures in 1998-1999 geared toward deepening our financial markets. We expect the secondary market for government securities to develop further as the CBA relies more on repo and reverse repo operations for managing liquidity in the banking system. We will also endeavor to take steps to increase the number of dealers and to develop the legal and institutional framework for the securities market, including the creation of a Securities and Exchange Commission.

23.  The government intends to continue addressing the financial rehabilitation of the energy sector through a combination of cost reduction measures, domestic debt workouts, and tariff increases. In this endeavor, we will adopt a cost-cutting plan for the energy sector covering the period 1999-2000 which will include six monthly performance targets on reduced technical and nontechnical losses, own use of electricity by power plants, revenue collection rates, and electricity generation mix. By the end of 1998, the government will take stock of the energy sector’s payables to domestic suppliers and will seek to conclude bilateral debt restructuring agreements by the end of March, 1999. With regard to tariffs, on November 11, 1998 the Energy Regulatory Commission announced that effective January 1, 1999 electricity tariffs will be increased on average by 12.5 percent. Thereafter, the adequacy of the tariff structure will be subject to semi-annual reviews in consultation with the World Bank; the first such review will be held in June 1999.

24.  We assign a very high priority to the civil service reform program and will endeavor to accelerate the development and initial implementation of a comprehensive strategy with the assistance of the World Bank. To facilitate this task, we have set up and empowered a high level government commission, which will coordinate and oversee civil service reform issues. The main task of this commission is to develop a medium-term civil service reform program, conduct a pilot survey to assess the quality of delivery of public services, and ensure that the draft civil service law to be submitted to parliament in accordance with international best standards. Until a comprehensive strategy is developed, we will continue to reduce the number of public sector employees in 1999 according to self-imposed targets to be announced before the end of 1998.

25.  We would like to reiterate our interest in participating in the Fund’s Special Data Dissemination Standards (SDDS). To this end we have nominated a coordinator for the SDDS and intend to increase our efforts to improve the compilation and dissemination of statistical information, particularly in the areas of international reserves, monetary and fiscal aggregates, external debt and official financial assistance.

26.  During the period of the program, neither the government nor the central bank will impose or intensify any exchange restrictions, introduce or modify any multiple currency practices, conclude any bilateral payments agreements that are inconsistent with Article VIII, or impose or intensify any import restrictions for balance of payments purposes.

27.  To achieve our targets under this program we have established performance criteria for end-March 1999, and indicative benchmarks for end-December 1998, and for end-June and end-September 1999 as set out in Table 1, and defined in the Technical Annex. These quarterly benchmarks will be reviewed with the IMF staff in the context of the mid-term review under the third annual arrangement under the ESAF, which we expect to begin discussing in March 1999 and to complete by June 14, 1999. We also intend to undertake a series of structural policies between now and the end of March 1999 in line with the schedule specified in Table 2.

28.  We believe that the policies and measures set forth in the attached memorandum are adequate to achieve the objectives of the program, but will take any further measures that may be necessary for this purpose. Moreover, we will remain in close consultation with the IMF. During the period of the program, we will consult with the Managing Director on the adoption of any measures that may be appropriate at our initiative or whenever the Managing Director requests such a consultation. Moreover, after the period of the program and while the Republic of Armenia has outstanding financial obligations to the Fund arising from loans under the third annual arrangement, we will consult with the Fund from time to time, at our initiative or whenever the Managing Director requests consultation on the Republic of Armenia's economic and financial policies.

2.  Submit to parliament a request for authorization to use additional proceeds from the Privatization Account in 1998 for the equivalent of dram 5.5 billion to help finance the net payment to the EU required under the external debt restructuring agreement about to be concluded.

3.  Conclude the procedures to formally withdraw the guarantee extended by the CBA on the $7 million loan facility provided by Deutsche Bank Luxembourg S.A. to the Armenian Import-Export Bank. The CBA guarantee shall be withdrawn without financial prejudice to the government, and no official resources of the government or the CBA will be attached or used as collateral in case of default by borrower.

2.  The government will reduce its share holdings in Ardshinbank to no more than 14 percent of total capital, through a public auction of the shares, through a public offering to raise additional capital, or by using any other mechanism available.

3.  The government will issue a decree establishing both dram and physical limits on the consumption of energy by "strategic consumers"(as defined in the Technical Annex to the Memorandum of Economic and Financial Policies) that will be supported by budgetary resources in 1999.

4.  The government will complete the sale of all remaining flour mills and bakeries. Bankruptcy procedures will be initiated against those enterprises in this sector which could not be sold for the third time.

Privatization and Public Enterprise Reform: (i) The government will approve in consultation with the assistance of the staffs of the Fund and the World Bank an action plan conducive to the development and implementation of a medium term strategy for the use of privatization proceeds; and (ii) the government will begin monitoring the financial operations of the five largest enterprises that will remain under public ownership in the period 1999-2000.

Energy Sector Reform: The government will conclude all restructuring arrangements of the energy sector’s overdue payments to domestic creditors outstanding as of the end of 1998.

Civil Service Reform: The government will: (i) complete an assessment of the number of physical persons by grade and by ministry employed in the public sector and prepare an action plan for undertaking a comparator pay survey to study the private-public sector pay differential; (ii) identify the technical assistance requirements for institutional strengthening and capacity-building in the area of civil service management; and, (iii) conduct a pilot service delivery survey to assess the quality of delivery of services and improve its efficiency.

Data Dissemination: The MFE will start publishing quarterly reports on all external grants and loans in kind received as well as the monetization of such grants and loans.

Treasury Management: (i) The MFE will set up a system to monitor the operations of all remaining extra budgetary funds; and (ii) the MFE will prepare a prioritized list of critical maintenance expenditures and investment projects to be included in the budget for the year 2000.

Privatization and Public Enterprise Reform: The government will initiate the monitoring of an additional five of the largest public enterprises that will remain under public ownership in the period 1999-2001.

Banking Sector: (i) an external audit of the Savings Bank will be completed and the government will define a strategy to be pursued for restructuring the bank, in consultation with the staffs of the World Bank and the Fund; and (ii) the government will sell all its remaining shares in Ardshinbank.

Energy Sector Reform: The government will prepare an assessment of the effectiveness of the cost reducing measures adopted since late 1998 and complete a review of the adequacy of the electricity tariff structure for the second semester of 1999 in consultation with the World Bank.

Treasury Management: The MFE will adopt a strategy to reduce the number of extrabudgetary funds, including defining those which will be consolidated in the budget for year 2000.

Banking Sector: The CBA will establish new banking regulations regarding: (i) loan classification guidelines, that include factors other than number of delinquent days and require banks to establish a more comprehensive loan loss reserve methodology; and (ii) classification and appraisal guidelines to determine the overall quality of banks’ investment portfolios. The government in consultation with the CBA will submit to parliament amendments to the Banking Law to give bank regulators the power to restrict dividend payments when banks are experiencing financial difficulties.

Social Safety Net: The government will: (i) issue a resolution stating its commitment to develop a pension reform strategy. The resolution will include the main principles of such strategy; (ii) approve a plan for the rationalization of both collection of payroll taxes and payments of pensions to recipients; and (iii) develop and approve a three-year strategic plan for the health sector.

30.  Quantitative targets are presented in Table 1, and defined below. Quantitative benchmarks are set for end-December 1998, while indicative quantitative targets are set for end-June and end-September 1999. Performance criteria are set for end-March 1999.

Ceilings on the net domestic assets of the CBA

31.  Net domestic assets of the CBA are defined as reserve money of the CBA ³ minus total net international reserves⁴ (as defined below). The CBA’s net domestic assets comprise: (i) gross credit to the general government (as defined below) from the CBA minus deposits, including deposits of the project implementation units (PIUs) of the general government with the CBA, exclusive of accrued interest; (ii) outstanding credit to domestic banks by the CBA (including overdrafts) minus liabilities to banks arising in connection to deposit auctions and reverse repo operations, exclusive of accrued interest; and (iii) all other net assets of the CBA (other items, net). Thus defined, the outstanding stock of the CBA’s net domestic assets amounted to dram 2,530 million on September 30, 1998. The limits for December 31, 1998, and March 31, June 30, and September 30, 1999 are specified in Table 1.

Ceilings on the domestic banking system net credit to the general government

32.  The banking system is defined to comprise the CBA and all commercial and specialized resident banks, including the Savings Bank of Armenia. The general government is defined as comprising the republican⁵ and local governments, as well as the Pension and Employment Fund (PEF). Accordingly, net credit of the banking system to the general government is defined as the consolidated gross credit given to the general government by these institutions minus the consolidated liabilities of these institutions to the general government, and excludes accrued interest which will be recorded in other items net. Liabilities of the CBA to the general government are defined to exclude any balances on the Privatization Account. Thus defined, the stock of net credit from the banking system to the general government was dram 16,136 million on September 30, 1998. The limits on the net credit to the general government for end-December 1998, end-March 1999, end-June 1999, and end-September 1999 are specified in Table 1.

Floors on net official international reserves

33.  The program targets a minimum level of net official international reserves in convertible currencies. The stock of such reserves will be calculated as the difference between total gross international reserves in convertible currencies at the CBA and total official reserve liabilities of the CBA in convertible currencies.

34.  Total gross official international reserves shall be defined as the CBA’s holdings of monetary gold, excluding amounts pledged as collateral or in swaps, holdings of SDRs, any reserve position in the IMF, and holdings of convertible currencies, in cash or in nonresident foreign banks. Foreign assets corresponding to the balance on the privatization account are excluded from the definition of reserve assets. Capital subscriptions in foreign financial institutions and nonliquid assets of the CBA are excluded. For program monitoring purposes, official gold holdings shall be valued at $330 per ounce.

35.  Official reserve liabilities in convertible currencies shall be defined as outstanding liabilities to the IMF, and other convertible currency liabilities of the CBA to nonresidents with an original maturity of up to and including one year.

36.  For program monitoring purposes, international reserve assets and liabilities in convertible currencies denominated in currencies other than the U.S. dollar shall be converted into U.S. dollars at the exchange rates that prevailed at the time of the start of the second arrangement approved in early 1997, and into drams at the program’s exchange rate of dram 470 per U.S. dollar.

37.  Thus calculated, the stock of net official international reserves in convertible currencies amounted to $102.0 million on September 30, 1999. The minimum stock of net international reserves in convertible currencies is set at $99.5 for December 31, 1998; $95.0 for March 31, 1999; $94.0 for June 30, 1999; and $96.0 for September 30, 1999. The stock of net international reserves does not include the balances on the privatization account described below.

Ceilings on the contracting and guaranteeing of new concessional external debt by the government and by the CBA

38.  External debt limits apply to new medium- and long-term external borrowing with original maturities of more than one year, that are contracted or guaranteed by the general government (as defined above), or by the CBA, with a sublimit on such debt with maturities of more than one year up to and including five years. In addition, there are limits on net disbursements of short-term external debt contracted or guaranteed by the general government or the CBA; all obligations with original maturities of up to one year fall under this limit, except normal import-related credits and CBA reserve liabilities. The outstanding stock of short-term external debt on September 30, 1998 was set at zero.

39.  Excluded from the limits are sales of treasury bills to nonresidents, provided the sales go through the regular auction mechanism and involve no exchange rate guarantees, and concessional loans. For program purposes, a loan is considered concessional if the grant element is at least 35 percent calculated using a discount factor based on the Commercial Interest Reference Rates (CIRRs) published by the OECD plus margins depending on the loan maturity.⁶ The average of the CIRRs over the last ten years will be used for loans with a maturity of at least 15 years and the average of the preceding six months will be used for shorter maturities. For the purpose of monitoring compliance with the targets, all agreements concluded in respect of rescheduling or refinancing of existing debt shall be excluded from the limits. Any amendment to the loan agreement with the Russian Federation that entered into effect January 8, 1998, or any other new contract that may need to be signed to ensure that the total value of the loan will be the equivalent of $35 million dollars will be also excluded from the limits. Disbursements on this loan will be valued at the market exchange rate of the day in which the disbursement is made and will be monitored separately to ensure that they will not exceed the equivalent of $35 million dollars until the end of 1999. Transactions subject to these ceilings shall be valued in the contracted currencies and converted into U.S. dollars at the average monthly market exchange rate in the month when the borrowing commitment was contracted. The limits for December 31, 1998, March 31, June 30 and September 30, 1999 are specified in Table 1.

Ceilings on external arrears

40.  For program purposes, external arrears of the general government or the CBA will consist of all overdue debt-service obligations (i.e., payments of principal and interest) arising in respect of loans contracted or guaranteed by the general government or the CBA since Armenia’s independence, unpaid penalties or interest charges associated with these arrears, and overdue payments owed by the general government or the CBA on imports received subsequent to independence. Thus defined, there were no external arrears at end-September 1998. No such new arrears shall be incurred during the period of the arrangement.

Limits on the overall state government budget balance

41.  For the purpose of the program, the overall state budget balance (comprising the republican and the local governments) is defined from the financing side on a cash basis as the sum of net domestic banking system financing, net domestic nonbank financing, and net external financing as detailed below:

42.  For program purposes, privatization proceeds will be defined to comprise all the cash proceeds from the sale of:

• shares owned by the state in state and nonstate enterprises and banks;⁷
  
• property of liquidated state enterprises;
  
• leased state property, including real estate, as described in footnote 7;
  
• building space, unoccupied residential dwellings;
  
• unfinished construction sites;
  
• right to use government resources;
  
• state property rights and state intangible property rights, including rights to subscribe to new issue of shares; and
  
• state enterprises or trusts, whether or not they have been restructured into state joint stock companies.
  

• property which has been confiscated or seized, acquired as a collateral or as a result of a trade agreement;
  
• property bequeathed to government, state administrative agencies, and local governments (including articles of cultural value, precious metals and stones); and
  
• proceeds from the sale of buildings and shares in 1999, as described in footnote 7.

44.  The program specifies that all privatization receipts (whether from domestic sales or international tenders) are to be deposited in a privatization account (PA) held with the CBA. The funds on this account will be managed by the CBA, or a reputable international investment bank chosen jointly by the government and the CBA, and will be invested in high quality foreign assets. During 1998 and 1999, all net income (interest or dividends) earned on the funds held on this account will be retained (capitalized) in the PA. The use of the net income from the PA for budgetary support will be reexamined at the time of the mid-term review.

45.  Before a comprehensive strategy for the use of privatization receipts is developed with the assistance of the IMF and the World Bank, the program allows only for a limited used of these proceeds for budget support. For 1998, the total use of privatization proceeds will be limited to dram 19.4 billion (2.1 percent of GDP), of which dram 10.5 billion will be used to finance the list of investment projects approved in the 1998 budget, and the rest to settle the debt restructuring with the EU. For 1999, the draft budget submitted to parliament calls for the use of privatization proceeds up to dram 11.35 billion to finance critical maintenance expenses and special investment spending projects. In each quarter of 1999, the government may use up to dram 2.838 billion from the PA for budgetary support, plus the difference between the actual quarterly use of privatization proceeds and the authorized quarterly amount, carried over from the previous quarter of 1999.

46.  For program purposes, the amounts outstanding in the PA at the end of each month will be included in the liability side of the monetary accounts of both the CBA and the banking system as a separate item labeled "privatization account." The counterpart of the PA will be accounted for on the asset side as "the foreign exchange counterparts to the privatization account." The PA will be excluded from the calculation of net credit from the CBA (and the banking system) to the government. Any withdrawal from the PA will be accounted for as privatization proceeds used to finance the budget (see above methodology to calculate the overall state budget deficit).

Budgetary expenditure arrears of the state government budget

47.  Each ministry of the Republic of Armenia will be responsible for ensuring the legitimacy of claims against the right of the spending unit to have incurred this liability under the respective budgetary allocation. This responsibility will be exercised through suitable post-audits of primary documents (such as tenders, contracts, verification notices, and payment orders) related to claims paid out to suppliers of goods and services to the spending ministries. Such audits will be conducted by inspection teams authorized by each ministry to visit each spending unit under its authority at least once a year.

48.  Each ministry will submit every month, a consolidated audit report of inspections carried out (in accordance with the above paragraph) to the Central Treasury for further action and record.

49.  Within 45 days of the end of each quarter, each ministry, in consultation with the Central Treasury, will ensure that all verified claims against the government made during the preceding quarter have been paid in cash. The Central Treasury will prescribe appropriate reporting forms (and indicate the frequency of reporting) to be used by the spending units for reporting expenditure arrears to the Central Treasury through their controlling ministry.

50.  For program purposes, verified claims relating to core expenditures against the government made during the preceding quarter which have not been settled within 45 days of the end of the quarter will be considered expenditure arrears.

51.  Expenditure arrears will be measured against core expenditures as defined in the tabulation below. The level of spending to be authorized during the last quarter of 1998 and the first quarter of 1999 is indicated next to each category of core expenditure. These spending levels exclude contingent expenditures. The government will incur in arrears when the payments of the core expenditures listed in the attached tabulations are not made within the time limit specified above.

52.  The MFE will not extend state guarantees on commercial borrowing from domestic banks by enterprises with a maturity longer than the fiscal year in which they are extended, unless specifically provided for in the budget, and only against a specific budget appropriation that covers the full face value of the guarantee. The provisions against guarantees—whether budgeted or not—will be used only if after exhaustive investigation, it is concluded that the borrowing enterprise is deemed not able to make the scheduled debt service payments. In this event, the government will initiate legal proceedings against the enterprise in order to recover the budgetary costs.

Quantitative benchmarks on dram broad money and reserve money

53.  Dram broad money of the banking system is defined as the total of currency outside banks, plus banking system deposits of households and enterprises in drams, excluding accrued interest. Thus defined, dram broad money does not include deposits of the republican and local governments, nor of the Pension and Employment Fund. Accrued interest on deposits held with commercial banks will be recorded in other items net. The banking system includes the CBA and all commercial and specialized resident banks, including the Savings Bank. The outstanding stock of dram broad money amounted to dram 53,275 million on September 30, 1998. The limits for December 31, 1998, March 31, June 30 and September 30, 1999 are specified in Table 2.

54.  Reserve money of the CBA is defined as the sum of currency issued outside the CBA, legally required reserves on deposits (both in dram and foreign exchange) and any other monetary liability of the CBA. The outstanding stock of reserve money amounted to dram 50,480 million on September 30, 1998. The limits for December 31, 1998 and March 31, June 30 and September 30, 1999 are specified in Table 1. On an experimental basis, the CBA has established that at any point in time within each quarter the indicative limit on reserve money can be exceeded by up to dram 1 billion. As this upper limit is reached, the CBA will take immediate corrective action to eliminate the deviation by tightening credit, including open market operations, or by allowing the exchange rate to appreciate.

The energy rehabilitation plan

55.  In order to ensure a successful implementation of the financial rehabilitation strategy of the energy sector, by December 15, 1998, the government will set a maximum physical and dram limit on the amount of electricity consumption on the basis of which it will determine the budgetary support that will be authorized for strategic consumers (Irrigation, Yerevan drainage, Armenian drainage, Yerevan metro, and budget supported companies) in 1999. Whichever limit is reached first, it will be the responsibility of the energy enterprises to collect payment for any additional energy supplied, or to suspend the service.

56.  To ensure that the projected financial gap of the energy sector (currently estimated at $74 million) remains within manageable limits, the government has undertaken to:

• introduce efficiency enhancing measures aimed at reducing losses and improve collections of overdue payments starting in the last quarter of 1998, with an expected yield of about $22 million.

• limit the amount of gas-for-equity swaps to be conducted by Gazprom/Itera to $42 million in 1999.

• conclude the restructuring of all internal debts of the energy sector to domestic suppliers outstanding as of the end of 1998 no later than March 31, 1998.

• Implement the decision of the Energy Regulatory Commission to increase the average electricity tariffs by 12.5 percent effective January 1, 1999, for a yield of about $14 million.

58.  The financial rehabilitation plan of the energy sector vis-à-vis the government will not involve any tax privileges. Nor will the government extend any guarantees on domestic borrowing or issuance of debt instruments, such as bills of exchange, by the energy enterprises.

59.  The government and the CBA will provide the IMF with the necessary economic and financial statistical data to monitor economic developments and program performance criteria. In particular, the government and the CBA will provide the following specific information:

The balance sheet of the CBA

60.  Monthly data will be reported to the Fund by the CBA within seven days of the end of each month. The information provided will clearly identify the following items: net domestic assets of the CBA, net credit from the CBA to general government, net credit provided to commercial banks (by type of credit), and any other financing provided to the rest of the economy, calculated in accordance with the definitions in this Technical Annex.

The balance sheet of the consolidated banking system

61.  Monthly banking system data, in the form of a monetary survey, will be reported to the Fund by the CBA within 21 days of the end of the month. The information provided should clearly identify the following items: net domestic assets of the banking system, net credit from the banking system to general government, and other financing provided to the rest of the economy.

Treasury bill financing

62.  The Central Bank will provide monthly data to the Fund within seven days of the end of the month on the amount of treasury bill holdings by the following categories of holders: the CBA, resident banks, resident nonbanks, and nonresidents.

International reserves

63.  The CBA will provide detailed monthly data within 14 days from the end of the month on both gross and net international reserves in convertible currencies, and holdings of monetary gold. These data will be provided at two alternatives sets of exchange rates and gold price: first, at those used to derive the NFA position in the CBA accounts; second, at those specified in the program.

External debt

64.  The Ministry of Finance, together with the CBA, will provide information on the net disbursements and outstanding stock of short-term external debt; on contracting and guaranteeing and the outstanding stocks of medium- and long- term external debt of the general government and of the CBA; and any stock of outstanding arrears on external debt service payments within 21 days of the end of each month. In addition, the Ministry of Finance will report the total amount of outstanding government guarantees and external arrears.

Tax and expenditure arrears

65.  The Ministry of Finance will report monthly on the amount of outstanding tax arrears and quarterly on budgetary expenditure arrears.

Tax revenues, nontax revenues and grants

66.  The CBA will report monthly the balance on government deposit amounts at the CBA for tax revenues, nontax revenues, cash grants and proceeds from the sales of humanitarian assistance. This information will be reported within 14 days of the end of each month.

Budgetary sector employment

67.  The Ministry of Finance shall provide monthly updates on budgetary employment by Ministry, and on average budgetary sector wages within 30 days of the end of each month.

Budgetary and extrabudgetary data

68.  Quarterly data will be reported to the Fund by the Ministry of Finance and the Pension and Employment Fund within 21 days of the end of each quarter. All receipts (tax and nontax revenues), all cash expenditures (including debt-service payments), and external and domestic borrowing operations will be part of this report. Expenditure data will be provided according to both economic and functional classifications, consistent with GFS methodology.

Nonbudgetary domestic arrears

69.  The Ministries of Finance, Economy and Energy, and the CBA and the Ministry of Statistics will coordinate so as to report to the Fund on a monthly basis the stock of arrears of the 50 largest enterprise debtors to the banking system, and energy arrears of households and enterprises. This information is to be provided within 30 days of the end of each month.

Balance of payments data

70.  The Ministry of Statistics will provide current account data, including data on foreign trade, estimates of foreign investment and private transfers, on a monthly basis, with at most a two-month lag.

Other general economic information

71.  The CBA will provide information on exchange rates (including the official, auction and interbank exchange rates, foreign exchange auction and interbank turnover, and the volume of CBA sales and purchases) and interest rates by maturities (including the refinance rate, the interbank rate and volumes, the credit auction rate and volumes, the treasury bill yields and volumes by maturity, and bank deposit and lending rates by maturity) on a monthly basis. Data for the month will be provided within ten days of the end of the month. The Ministry of Statistics will notify the Fund of the monthly Consumer Price Index by category by the 5th of the following month, and convey quarterly GDP estimates within two months of the end of each quarter.

Privatization proceeds and use of privatization proceeds for budgetary support

72.  The CBA will provide on a monthly basis to the Fund the balance on the privatization account held at the CBA, as well as all gross additions and gross withdrawals from it both in drams and in U.S. dollars no later than five days after the end of each month.

The energy sector rehabilitation plan

73.  The government will provide a quarterly report on the consolidated operations of the energy complex, including net sales proceeds, current and capital expenditures, and the sources of financing.