Tirana, December 12, 1998

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

Dear Mr. Camdessus:

1.  Since the IMF Executive Board approved the first annual arrangement under the ESAF in May 1998, the authorities of the Republic of Albania have continued to implement the strong stabilization policies initiated after the severe crisis of 1997. All end-September quantitative performance criteria were met, inflation has declined sharply, and output is expected to recover to its pre-crisis level by end-1998. Also, structural reforms are underway in many areas, and the end-September structural performance criterion on deciding on privatization of the National Commercial Bank was observed.

2.  The good progress in stabilization and reform was interrupted by a short period of civil unrest in September. Soon thereafter, in early October, the present government took office. Although the turmoil caused some economic disruption, macroeconomic indicators have remained broadly on track. However, the structural performance criterion on reducing the workforce in budgetary institutions to 135,000 by end-September could not be observed.

3.  The Albanian authorities remain committed to the macroeconomic and structural objectives of the ESAF-supported program, and the attached Supplementary Memorandum on Economic and Financial Policies describes the progress made and the additional measures we will implement to achieve those objectives. On the strength of these policy measures, including our commitment to complete the reduction in budgetary employment to 135,000 by end-1998, we would like to request a waiver for the nonobservance of the above-mentioned performance criterion. If necessary, we are prepared to take further measures to ensure the success of our program, after consulting with the Fund.

4.  We have also reached understandings with Fund staff on the key parameters of our 1999 draft budget which we expect parliament to approve before the end of the year. If approved, this budget could serve as a basis for agreeing on the second annual arrangement under the ESAF in support of our economic program for April 1999–March 2000.

Sincerely yours,

1.  Despite recent disturbances, macroeconomic developments in 1998 have been broadly on track. An episode of civil disorder in September, together with the Kosovo situation, has reduced economic and investor confidence, but the government estimates that the momentum from earlier in the year will result in real GDP growth for the year of 8 percent, only slightly below the targeted 10 percent and still implying a return of output to the level prevailing before the devastating crisis of spring 1997. The moderate increase in prices of 6 percent during the first three quarters suggests that the target of 10 percent inflation during 1998 is well within reach. In the external sector, the lek has been stable for more than a year, and the current account deficit is estimated to decline sharply from over 12 percent of GDP last year to below 8 percent this year, reflecting unexpectedly buoyant private transfers and somewhat lower than envisaged imports.

2.  Financial policies have been fully on course. The quantitative performance criteria for end-September have been met, some with large margins (Table 1). The domestically financed fiscal deficit (with privatization receipts counted as financing) is estimated to be slightly below the targeted 6.6 percent of GDP for the whole year, and more than 4 percent of GDP below last year's outcome. The deficit reduction was achieved mostly through strong revenue efforts (tax collection rose by nearly 3 percent of GDP), but tight expenditure control also contributed. The monetary program is also expected to remain well on track. Broad money has been below the projected level, and reserve money and net domestic assets of the Bank of Albania have actually fallen during the year, rather than having increased as projected. The latter development reflects an encouraging marked shift by the public from holdings of cash to bank deposits.

3.  The generally good progress on structural reform was disrupted by the recent turmoil and the resignation of the government in late September. Until then, implementation was on schedule in many areas, including winding up the pyramid schemes, banking reform, and creating a functioning agricultural land market. However, the disturbances resulted in delays in structural reforms. In particular, while one of the two structural performance criteria for end-September (deciding on privatization of the National Commercial Bank) was met, the other (establishing a ceiling on employment in budgetary institutions at 135,000 and reducing the workforce to this level) was missed. Regarding the latter, cuts of 15,000 employees (10 percent of budgetary employment) had already been made over the past year, but the remaining cuts of some 1,000 employees, mostly in the Ministries of Defense and Public Order, could not be completed at the time of the turmoil.

4.  The new government that took office in early October is firmly committed to continued macroeconomic stabilization and structural reform. Economic policies will continue to be conducted in the framework of a medium-term program for April 1998–March 2001 which the Fund is supporting under the ESAF. Although some time has been lost because of the turmoil, the government is determined to keep the program on track. The remainder of this memorandum sets out in detail the financial policies and structural reforms for the period ahead. The government believes that the policies set out below will be sufficient to achieve the program objectives, but it will take additional measures and seek new understandings with the Fund should the program diverge from its specified targets.

5.  Achieving sustained rapid growth in a low-inflation environment remains the government's main economic goal (see tabulation below). This should help to create jobs and reduce poverty, the government's key priorities. The growth objective for 1999 has been increased slightly, in part to take into account the lower base in 1998 but also because the government aims to accelerate reform efforts and do all it can to improve the domestic security situation, a precondition for sustained growth. For external viability, the authorities now target somewhat higher gross official reserves (equivalent to some 4 months of imports of goods and nonfactor services) than originally envisaged, owing to an increased country risk related to the Kosovo situation and the recent instability. The lower-than-expected external current account deficit this year has allowed the government to aim for a smaller deficit in 1999 than originally envisaged.

6.  The government has reached understandings with IMF staff on the key parameters and policies of the draft 1999 budget. Parliament is expected to approve the budget by end-1998, consistent with the timetable set out in the new organic budget law that came into force in July 1998. The draft budget envisages a reduction in the domestically financed budget deficit from this year's estimated outcome of 6½ percent of GDP (of which less than ¼ percent of GDP is covered by privatization receipts), to 5½ percent of GDP (of which privatization receipts are projected to cover ½ percent of GDP) in 1999. The fiscal adjustment planned for next year is even stronger than implied by this reduction, as the government will have to make up for a decline in external budget support to 1 percent of GDP from the exceptionally high level of about 2 percent of GDP reached in 1998. The overall deficit, including foreign financed investment, is projected to decline markedly, from 11 percent of GDP this year to 9¾ percent of GDP in 1999. The government believes that the revenue and expenditure measures described below are sufficient to achieve the fiscal targets, but is prepared to take additional steps as needed. Beyond using the 5.1 billion leks (1 percent of GDP) provided in the draft budget under the reserve and contingency funds, the government would cut noninterest current spending to prevent any slippage.

7.  In the context of the 1999 budget, the government will take major revenue measures both to raise the tax-to-GDP ratio and to modernize the tax system. First, following a review of the system of direct taxation undertaken with IMF technical assistance in summer 1998, the government has prepared a new direct tax law which it aims to make effective from January 1, 1999. The new law includes a number of significant measures: introduction of a 10 percent withholding tax on interest income; raising the rates of the personal income tax, with the top marginal rate increasing from 20 to 30 percent; widening of the personal income tax base to include bonuses; introduction of a simplified system of depreciation in calculating the profit tax; and abolition of new tax holidays. The combined revenue effect of the direct tax measures is estimated to be 0.4 percent of GDP in 1999. Also in the direct tax area, the government is committed to not introducing tax holidays for companies in any planned free zones. Second, also effective from January 1, 1999, excise taxes on domestic and imported goods will be unified at rates which are estimated to be at least revenue neutral. Third, the government is in the process of formulating a plan for customs tariff reform in the medium term, with IMF technical assistance (see paragraph 24). The first steps to rationalize the tariff structure and lower the average tariff rate will be taken effective April 1, 1999. To the extent the proposed reduction in the average tariff rate is expected to reduce revenue, the government is committed to taking compensating revenue measures in consultation with IMF staff. Another new feature of the tax system is increased decentralization which started already in May 1998 with the transfer of the administration, collection, and use of the property tax to local governments. Local governments will also take over responsibility for some expenditure, with the gap between projected expenditure and revenue being filled by a block grant from the central government. The government expects that over time the fiscal decentralization will enhance collection efforts and increase accountability for expenditures, while improving the financial position of the consolidated government. Overall, tax revenue in 1999 is projected to reach some 13¼ percent of GDP, an increase of ¾ percent of GDP from 1998. The ratio of total revenue to GDP will rise only marginally, however, as the profit transfer from the Bank of Albania will decline relative to GDP, owing to both the reduced need for and the lower cost of financing the budget deficit.

8.  The draft 1999 budget incorporates strong efforts to contain expenditure. Total expenditure will decline from 31½ to 30 percent of GDP despite some increase in spending on investment which the government considers necessary for improving infrastructure and for ensuring adequate facilities for the health and education sectors. There will also be a need to cover the interest costs of recapitalizing the state-owned banks which, however, are not expected to exceed ¹/3 percent of GDP in 1999. Current spending will decline markedly relative to GDP, in part because of lower interest payments on domestic debt, but mostly because of discretionary spending decisions. First, determined efforts to keep personnel expenditure in check (which in 1998 will have included a 10 percent cut in budgetary employment) will continue. The draft budget provides for a moderate general wage increase of 10 percent effective April 1, 1999. Moreover, budgetary employment will be reduced further by some 1½ percent, with the expenditure savings being used to cover the costs of further wage decompression (paragraph 19). Pensions will also be increased by 10 percent, effective January 1, 1999. Second, improved monitoring will help to reduce spending on social assistance relative to GDP, without weakening the economic position of those in need. In the past, the planning and delivery of social assistance has been hampered by lack of firm data on the number of eligible families. For 1999, the budget law will stipulate that only 35 percent of the annual allocation will be released by end-June 1999, by which time the Ministry of Labor and Social Affairs is obligated to have compiled a comprehensive database on recipient families. Overall, the budget allocation for social assistance in 1999 has been reduced in real terms, as improved economic conditions should reduce the number of recipients. However, should the number of eligible families not fall as expected, the government will make available additional resources for social assistance from the reserve and contingency funds. Also in the social area, the public works program which was stepped up significantly in 1998 with assistance from the World Bank to reduce the impact of last year's crisis on the poor will be continued, albeit at a diminished level. Moreover, provision will be made in the budget for a further allocation of public funds for housing loans, which will augment funds provided in previous budgets and not yet disbursed. Third, spending on operations and maintenance will continue to be kept under strict control. Since spending in important areas, such as investment and operations and maintenance, is already rather low after being squeezed markedly in recent years, the government is committed to raising these and other priority expenditures to more adequate levels as quickly as possible over the medium term. Indeed, should revenues overperform significantly over the next year, the government would consider using the overperformance to enhance spending in the critical areas already in 1999.

9.  To ensure the attainment of the revenue targets, customs and tax administration will continue to be strengthened. In the area of customs administration, the government is committed to continuing the successful cooperation with the EU Customs Assistance Mission to Albania which since mid-1997 has devoted major resources to rebuilding and reforming the customs service. In particular, installation of the pre-arrival intelligence system (PAIS) and the presence of EU experts in key customs posts has helped to improve enforcement and raise collections. Progress has also been made recently in making the customs reference valuation file operational, with 80–90 percent of the dutiable items in the Tirana and Durres offices (which cover the bulk of imports) now being covered by this file. The government intends to take all the necessary steps to ensure the full implementation of the reference valuation file in the major customs clearance houses by end-March 1999. A new customs code, prepared with EU and Fund advice, is expected to be approved by parliament by end-1998, and will be implemented without delay. The government will seek technical assistance from the EU Mission for training customs officials in the application of this code. Also, the government is preparing a plan for collecting customs duty arrears, including through improving cooperation between customs and the General Prosecutor's office. In addition, recruitment has been made more transparent, some 30 anti-smuggling officers hired from outside the customs service are being trained in Albania and abroad, and will assume their duties in early 1999, and the Internal Audit Unit is being strengthened. As for tax administration, the Ministry of Finance has prepared a new fiscal code that will make tax procedures more transparent and strengthen enforcement. The government expects parliament to approve it in early 1999, and the code would come into force before end-March 1999. Moreover, VAT documentation is being improved (through turning VAT receipts into secure paper printed by the Bank of Albania, to be introduced in early 1999), 7 additional tax offices are being computerized with funds already approved under the Tax Administration and Modernization Project, and training for tax officials and taxpayer education have been increased. The government will also work with the World Bank to improve the operations of the large taxpayers' office.

10.  The government will continue to improve budgetary procedures and public expenditure management. The 1999 budget has been prepared according to the new organic budget law, with more transparent procedures. Also, as stipulated by this law, work is underway to present expenditures in the 1999 budget using a functional classification. To clarify expenditure priorities, the government will initiate a Public Expenditure Review during 1999, in consultation with the World Bank. The introduction of a cash management system in the treasury department has been delayed because of the withdrawal for security reasons of a foreign expert, but the government is seeking alternative financing to continue the project, with completion expected by end-March 1999. The government will also draw on the advice of an IMF technical assistance mission which will review public expenditure management and create a work plan in January 1999.

11.  The Bank of Albania (BoA) will continue to maintain an appropriately tight monetary stance to help reduce inflation, its main objective. While benefitting from the decline projected for the domestically financed deficit in 1999, the BoA will also continue with appropriate interest rate and exchange rate policies. The minimum deposit rates for state-owned banks will be kept at levels which are positive in real terms, with the timing and amount of nominal rate changes being based on an assessment of price developments, the demand for lek deposits, and conditions in the foreign exchange market. The BoA will continue to operate under a flexible exchange rate regime, generally limiting intervention to that necessary to smooth excessive fluctuations in the exchange rate. While supporting this policy, the BoA intends to make modest sales of foreign exchange in the market over the next few months to remain consistent with the reserves target and to satisfy the economy's import needs.

12.  The monetary program for 1999 is geared to ensuring that broad money expansion remains consistent with the inflation objective. On the assumption of a broadly constant velocity during 1999, and given projected real GDP growth and inflation, this would imply broad money growth of about 16 percent. This expansion should be sufficient to meet the needs of the budget, and also allow a modest increase in official reserves and a significant increase in credit to the private sector. In 1998, there was a significant fall in the currency-deposit ratio, partly as a result of high real interest rates. The ratio is expected to stabilize in 1999, as real interest rates return to more normal (though still strongly positive) rates and as the government introduces the new withholding tax on interest income. However, the fall in the ratio which has already occurred will still result in the increase in the net domestic assets of the Bank of Albania being much less than programmed. The indicative targets for end-December 1998 and end-March 1999 will be tightened as shown in Table 1 to reflect this. The program for 1999 will be finalized at the time of discussions on the second annual ESAF arrangement early next year.

13.  The Bank of Albania intends to start to replace bank-by-bank credit ceilings with indirect instruments of monetary policy in the course of 1999. A necessary condition for the removal of the ceilings will be strong banking supervision to monitor and constrain, if needed, individual banks. Credit ceilings on individual banks have been applied for some years, partly to ensure that aggregate credit to the private sector remains consistent with the inflation objective and partly to limit lending by banks with bad lending practices, as reflected by the high proportion of bad loans in their portfolios. For the latter group, the Bank of Albania will continue to apply credit ceilings to strictly limit new lending indefinitely. However, for other banks, the Bank of Albania intends to improve banking supervision sufficiently so that it can remove the ceilings and rely on indirect monetary instruments to control aggregate credit in the course of 1999. To this end, the Bank of Albania will be discussing with a forthcoming IMF technical assistance mission the adequacy of banking supervision, means of developing the treasury bill market, and reserve money management. The Bank of Albania and the government also intend to make further progress with a comprehensive (and now well-advanced) agenda of legislation to create an adequate legal and regulatory framework for the banking system (see paragraph 16). Furthermore, the Bank of Albania intends to set up a Credit Information Bureau during 1999 to make transfer of information among banks easier and to facilitate lending to creditworthy customers.

14.  The process of winding up the pyramid scheme companies whose collapse precipitated the crisis of March 1997 is now close to completion. This has been achieved through strong efforts by the government, with assistance from the international financial institutions and donors. Foreign accounting firms appointed to administer and audit the companies have begun auctions of seized assets. The auctions, which are taking place under a liquidation law approved by parliament in July, are now expected to be completed by end-March 1999. The assets realized will then be returned to the depositors. The auditors' interim reports have already confirmed both the insolvency and the fraudulent nature of the companies, and their final reports, which are expected by April 1999, will certify that these companies were operating pyramid schemes. The government will continue to provide all necessary assistance to the administrators and auditors to help them complete their work, including providing information as needed and funds from the budget as necessary for completion of the liquidation process. The government has also taken steps to prevent a recurrence of the pyramid scheme phenomenon. Specifically, a money laundering law has been drafted and is expected to be approved by parliament early next year. Enforcement of the Companies Law and other commercial laws is being improved through additional training of the judiciary, with assistance from the World Bank and other donors.

15.  The government intends to privatize the remaining state-owned banks in 1999. Substantial progress has already been made in banking sector reform. The final stages of the liquidation of the Rural Commercial Bank (RCB) have now been completed. In June 1998 the Bank Asset Resolution Trust (BART) began operations with a mandate to undertake asset resolution for state-owned banks. In December 1998, treasury bills to the value of 4.2 billion leks will be issued to the Savings Bank to cover the total excess of liabilities over assets of the RCB which were transferred to the Savings Bank in December 1997. A foreign Chief Executive Officer (CEO) and privatization advisor have been appointed for the National Commercial Bank (NCB), and the government has made a formal decision to privatize the bank and has advertized it for sale. A meeting with potential buyers originally scheduled for September had to be postponed because of the turmoil, and this will cause some delay in the privatization. However, the meeting has been rescheduled for December, and at this meeting the government will ask interested buyers to prepare bids for the bank. A law on privatization of the bank will be approved by parliament by mid-January 1999, and the government expects to sign a sale contract by end-April 1999, with final legal arrangements for the privatization of the bank, including the clean up of its balance sheet, to be completed by mid-year 1999. The Savings Bank is now operating under a governance contract. Cooperation between the bank, its advisors, and the government has been good, and an action plan to streamline the bank's operations in preparation for privatization by end-1999 is being formulated. Among the key elements of this plan are: a full assessment of the bank's financial position and prospects; measures to improve the efficiency of the bank's payments operations; clarification of financial relations with the government, including possible compensation for the cost of services rendered for the Treasury; improving the internal audit system; evaluating the loan book and lending practices with a view to increasing private sector lending; repeal of an earlier Council of Ministers' decision that would have transferred the operations and assets of the National Housing Agency to the Savings Bank; and preparation of the legal framework for privatization.

16.  The government and the Bank of Albania are continuing to take steps to clarify and strengthen the legal, regulatory, and supervisory framework under which the banks operate. The Bank of Albania is in the process of drafting a law on collateral which will be sent to the Council of Ministers by end-March 1999. The government and the Bank of Albania will also continue to improve enforcement of the existing laws and regulations, in particular the Bankruptcy Law, in cooperation with the World Bank and other donors. During 1998, based on IMF and donor advice, banking supervision has been improved and licensing requirements for new banks and capital adequacy requirements for all banks are being tightened. In addition, a new chart of accounts has been prepared and introduced in the commercial banks, and the banks will formally move to the new accounting system on January 1, 1999. As noted above, the Bank of Albania is also working to develop indirect instruments of monetary policy, and has revised its regulations on reserve requirements and repurchase agreements to this end. The Bank of Albania and the government have also established a joint committee to coordinate the issuance of treasury bills and arrangements for profit transfers to the government. To improve the payment system, the Bank of Albania is in the process of introducing SWIFT communication with commercial banks for domestic, customer and inter-bank payments. Moreover, the Savings Bank has concluded agreements with Italian and Greek banks to allow low-cost transfer of remittances from Albanians in Italy and Greece. Further improvements are planned for 1999. In particular, the Bank of Albania is approaching other central banks in the region with a view to making arrangements for electronic transfer of remittances from banks in neighboring countries to their branches in Albania.

17.  The government will take every necessary step to accelerate enterprise privatization and restructuring. A solid foundation was laid in 1998: a comprehensive privatization strategy was approved in March; a closing date of June 1998 for submitting restitution claims was set, the government has accepted all the claims made, and expects them to be settled by end-March 1999 for settling the claims; the legal and regulatory framework for privatization has been completed in a number of strategic sectors and in all nonstrategic sectors; and the privatization of some 200 and liquidation of a further 290 small- and medium-sized enterprises (SMEs) already prepared for privatization or liquidation under previous programs was completed. However, there have also been delays in the process, in part related to external and domestic security concerns. For example, discussions with a potential strategic investor in the chrome company (Albchrom) were interrupted by the turmoil in September. Also, the government has in some cases delayed privatization of enterprises so that the prospects for sale to a single buyer who could best take effective control and promote efficiency in the enterprises could be enhanced. For this reason, while liquidation of the remaining six former Enterprise Restructuring Agency (ERA) companies which had been put on the list of enterprises slated for liquidation has been completed since May, removal from state ownership of the final four of the original 35 ERA enterprises through the privatization route has been delayed. Two of these will be privatized or liquidated by mid-January 1999, and the others will be privatized or liquidated by end-March 1999. The government also intends a significant acceleration of privatization of the remaining 470 SMEs in late 1998 and in 1999. Ninety companies accounting for some 80 percent of the total employment of the remaining SMEs will be offered for sale by the end of 1998, and the government expects that successful auctions for at least 50 of them will have been held by mid-January 1999. Another 300 will be offered for sale by end-March 1999, and the government is committed to completing the sale of over 400 of 470 SMEs by end-June 1999. The government also remains committed to the privatization of the strategic enterprises. The first candidate for sale is the mobile telephone company (AMC). A privatization advisor will be appointed by the end of 1998 and the company will be privatized by end-April 1999. The fixed telecommunications company (Telekomi Shqiptar) will follow later in 1999. In other strategic enterprises the government's priority has been improving financial and technical performance in preparation for privatization. Some 4,000 out of 14,000 employees of Albpetrol, the state oil company, have been dismissed. Improved procedures to combat electricity theft and reduce billing arrears have been put in place in KESH, the electricity company. However, serious problems remain, and further measures to improve the financial position and operations of KESH and the water companies are planned for 1999. In particular, efforts to collect arrears from state enterprises will be accelerated.

18.  The government has made considerable progress in creating a well-functioning agricultural land market, and will take further steps to consolidate this in 1999. Parliament approved a package of laws in May 1998 which clarified and simplified the legal framework for land transactions, abolished the system of priority claims in land sales, made provision for the leasing of agriculture land, including allowing foreigners to take out long-term leases, and allowed undistributed state lands to be used to compensate former land owners in cases where there are conflicting claims on land holdings. A regulation has been approved making possible special registration of land in villages where the registration process has not yet been undertaken. Finally, the government has opened land registries covering all districts. In 1999 the government intends to support the land registration process further by ensuring that increasing office space for land registries and setting up and providing funding for special validation commissions which can provide tapis (land use certificates) in villages where these were not issued. The government has also agreed that to monitor progress in land registration and the establishment of a land market there should be quarterly benchmarks on the number of cadastral zones for which first registration should be completed and on the number of land sale transactions. Specifically, registration had been completed in 766 cadastral zones at end-September 1998. The government aims to complete registration in 1,000 cadastral zones by end-December, 1998, and in 150 more zones during each quarter in 1999, to yield a total of 1,600 by end-December 1999. At end-September 1998, 1,530 sale transactions had been completed. The government aims to raise this number to 2,000 by end-December, 1998, to 2,500 by end-March 1999, to 3,000 by end-June 1999, to 4,000 by end-September 1999, and to 5,000 by end-December 1999. Land market reform is part of a comprehensive agricultural strategy which the government has prepared and which it expects to send to parliament in early 1999. This strategy aims at consolidating private property and the free market in agriculture, boosting production, increasing farm income and ensuring food security, while maintaining or improving Albania's liberal agricultural trade regime. As for the General Directorate of State Reserves (GDSR), whose operations will be phased out by 2000, the government is continuing to diminish the scope of its activities. Wheat reserves amounted to 14,500 tons in October 1998, and are expected to fall below 10,000 tons by end-1998. For end-1999, the government will target wheat reserves at no higher than 6,000 tons. Also in 1999, the number of GDSR units will be cut from 56 to 38, and the government will transfer some of GDSR's activities to the private sector.

19.  The government is committed to speeding up the reform of public administration and civil service. Significant progress has been made in 1998 in reducing overstaffing (through cuts in budgetary employment from 150,000 at end-1997 to 136,000 at end-September) and increasing wage differentiation (through wage increases ranging from 40 to 100 percent for over 17,000 security personnel, civil servants, and senior officials in April and through bonuses financed through a "solidarity tax"—a small surcharge on the profit and personal income taxes—for public order personnel since November). However, there have also been delays owing to insufficient administrative capacity (the Department of Public Administration has been severely undermanned) and the recent disturbances. In particular, the targeted reduction of budgetary employment to 135,000 was not achieved by end-September, and functional reviews of key ministries could not be initiated. To make up for the lost time, the government will take a number of measures in the coming months. By end-1998, the employment ceiling will be set at 135,000 and the remaining cuts made to comply with the limit. Employment monitoring will be facilitated by a comprehensive database of budgetary employment that the Department of Public Administration is compiling based on a recent survey. The database will be made fully operational by end-1998, and it will be shared by the Ministry of Finance and other relevant agencies. In November 1998, the Council of Ministers will issue a decision to conduct functional reviews in four agencies (the central administration and the Ministries of Finance, Justice, and Local Government), and the government is committed to completing two of them (including the review of the Ministry of Finance as a pilot case) by end-March 1999 with external technical assistance. Also, by end-1998, the Department of Public Administration will be strengthened to 14 employees (from the current 5). During 1999, further wage decompression will be achieved by using the expenditure savings from a further cut of 2,000 employees by end-March to increase the salaries of some 3,400 core civil servants.

20.  The government is determined to continue the fight against corruption. In June 1998, the government together with the World Bank organized a major anticorruption conference where the results of a survey of corruption in Albania were released and a wide-ranging set of recommendations discussed. In September, the government formally adopted the recommendations, is already taking some measures, and is fully committed to implementing the remaining ones on schedule. A monitoring group chaired by the Deputy Prime Minister has been formed, and now meets weekly. By end-December, parliament is expected to approve an amendment to the Law on the Organization of Justice to introduce testing of all judges appointed in the past ten years, to ensure a competent and qualified judiciary. The government is also preparing measures to improve implementation of the Public Procurement Law.

21.  Despite the reduction in the current account deficit to 7¾ percent of GDP in 1998, Albania's external financing requirements remain large. While there has been some pick-up in imports in 1998, Albania's investment and reconstruction needs continue to be great, and a further substantial increase in imports is expected in 1999. Exports can be expected to increase gradually in response to improvements in security environment, structural reforms, and macroeconomic stabilization, and private remittances are already approaching their pre-crisis level. However, the current account deficit will remain high at 9½ percent of GDP, and will need to be financed by a surplus in the capital account, from inflows of foreign direct investment, and committed bilateral and multilateral support. A somewhat higher reserve cover will also be necessary to provide additional insurance against the increased country risk. The financing gap for the first annual arrangement has been filled with exceptional external financing of close to US$270 million, but filling the gap for the second annual arrangement may require additional donor commitments. Detailed projections of financing needs will be made during the discussion on the second annual arrangement.

22.  Regarding external debt, the government will take steps to regularize relations with external creditors, including Paris Club creditors. Following a Paris Club agreement on the terms of reference for rescheduling Albania's debt in arrears to Russia and Italy in July 1998, the government has requested an extension of the deadline for concluding bilateral agreements and is working to conclude these agreements as soon as possible. The government cleared guaranteed arrears to Denmark under the 1993 Paris Club agreement on October 1, 1998, thus eliminating all external payments arrears that are not subject to rescheduling on terms consistent with the July 1998 Paris Club terms of reference. The government will also seek at least comparable treatment from other non-Paris Club official bilateral and commercial creditors with outstanding claims on Albania. Additionally, the government will continue efforts toward the removal of the remaining restrictions subject to Fund approval under Article VIII, Section 2 (a), in the form of outstanding debit balances under inoperative bilateral payments agreements.

23.  The government intends to improve aid monitoring and absorption markedly in the period ahead. A comprehensive and fully operational external debt database will be completed by end-1998, and a similar database for grants by end-March 1999. To this end, the government will formalize the procedural, institutional, and legal framework for monitoring and servicing external credits and grants by end-1998. While the external debt database will be located in and updated by the Ministry of Finance, the Ministry of Economic Cooperation and Trade and the Bank of Albania will be granted full access to this database. Similarly, the Ministry of Foreign Economic Cooperation and Trade will run the database on grants, but the Ministry of Finance and the Bank of Albania will have full access to the data. Also, the Ministry of Finance will appoint a foreign grants officer. To strengthen absorption capacity and remove obstacles to the timely disbursement of foreign aid, the government will simplify procedures relating to the approval of foreign financed projects, and provide adequate funds for VAT and customs duty coverage and land acquisition for foreign financed projects in the 1999 budget. Should the budget allocation for tax refunds and the local counterpart for foreign financed investment prove insufficient owing to faster-than-envisaged disbursement of aid, the government is committed to using the budget's reserve fund for this purpose.

24.  The government remains committed to trade reform and to the maintenance of a liberal trade regime. To this end, with the help of a November 1998 IMF technical assistance mission, the government will review the structure of tariffs, formulate a plan for rationalizing it by end-1998, and design offsetting fiscal measures if necessary, with initial steps to be taken by end-March 1999. The plan will involve a phased reduction in the average tariff rate over the medium term, through a combination of reductions in the level, number, and dispersion of rates. The medium-term aim will be to achieve a simple and transparent tariff structure with a relatively low (fiscal considerations permitting, close to a 10–12 percent unweighted average tariff rate, compared with the present 15.9 percent) and more uniform (no more than 2–3 nonzero bands) tariff rates. The government will also, in the 1999 budget, unify excise taxes on domestic and imported goods at rates that are at least revenue neutral, with the excise tax levied on the duty-inclusive customs value. As regards the few remaining quantitative restrictions, the government will remove the export bans on the remaining two scrap metals and on skins and hides by end-1998. The government abolished an export ban on wood and unprocessed wood products in June 1998 and is committed to maintaining a liberal export regime for these, in the short term preserving forestry reserves by licensing, and in the longer term by strengthening the implementation of forestry conservation programs.

25.  The government and the Bank of Albania will continue efforts to improve the quality, coverage, and timeliness of economic and financial data. Since spring 1998, the Ministry of Finance has published a new quarterly bulletin of government finance statistics. Also, as mentioned above, the government is in the process of completing the steps to establish comprehensive databases for external debt and aid. In other areas, the authorities will discuss a work program that would address the key deficiencies with a multitopic technical assistance mission from the IMF in February 1999. Major efforts will be necessary in a number of areas, especially in establishing a system of national accounts, and the government is committed to allocating sufficient resources to data development and compilation and to seeking external assistance as necessary to implement the work program without delay. The government and the Bank of Albania also intend to participate in the General Data Dissemination System (GDDS) as soon as feasible, and have already named a GDDS coordinator.

26.  During the remainder of the first annual ESAF arrangement, the program will be monitored based on indicative quantitative targets for end-December 1998 and end-March 1999 set on a cumulative basis from end-December 1997, and on the implementation of structural performance benchmarks (Tables 1 and 2). The government will also conduct with the Fund a mid-term review of the program no later than end-1998, and satisfactory agreement with Fund staff on a 1999 budget will be a condition for completing that review. The indicative quantitative targets include: (i) a floor on the net international reserves (NIR) of the BoA; (ii) a ceiling on the net domestic assets (NDA) of the BoA; (iii) a ceiling on the banking system's net credit to the general government (including extra-budgetary funds); (iv) a ceiling on the contracting or guaranteeing by the public sector of new nonconcessional medium- and long-term external debt in the maturity range 1–15 years, with a subceiling on the contracting or guaranteeing of new nonconcessional external debt in the maturity range 1–5 years; and (v) a ceiling on the stock of outstanding short-term external debt, with the exception of normal import-related credits. The NIR target will be adjusted upward and the NDA and net credit to government (NCG) targets downward for any excess in balance of payments or external budget financing above program projections. However, the NIR targets will be readjusted downward, and the NDA and NCG targets upward to the extent such financing is used for government imports. The NIR target will be adjusted downward and the NDA and NCG targets upward to the extent that there is any shortfall in balance of payments or budget financing from program projections, with the proviso that the downward adjustment to the NIR target shall not exceed US$20 million. During the program period, Albania will not impose or intensify exchange restrictions on current transactions or import restrictions for balance of payments reasons, and will not accumulate new external payments arrears, except for interest on obligations for which a rescheduling is expected.