dragutinovi} diana - doiserbia · although it sounds funny, ... adherence to wto disciplines ... a...

CONTENT

Introductory remarks1. Reform Agenda through Time2. The Role of the IMF3. The IMF Model and Empirical Framework4. The IMF in Serbia & Montenegro

4.1 Emergency Post-Conflict Assistance4.2 Stand-By Arrangement4.3 Extended Arrangement

5. Economic Policy and Reform: Recent Developments5.1 Comparative Analysis of Structural Reform Status5.2 International Status5.3 Economic Policy

6. Critical Issues7. Challenges in 2004

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Dragutinovi} Diana *

Economics is like red wine - you shouldn't smell it but drink it.But if you drink too much at once, there is a risk of dizziness.

THE IMF SUPPORTED PROGRAM INSERBIA & MONTENEGRO

^LANCI/ARTICLES

* Ekonomski fakultet Beograd

INTRODUCTORY REMARKS

The aim of the paper is to discuss the IMF-supported program and its objec-tives, design and outcomes in Serbia and Montenegro. It is very important to beclear as to what the facts are and what the policy options are, especially now,when Serbia and Montenegro has reached a crossroads in its development. TheIMF was invited in order to advice the policy makers on a reform strategy. Whatdid the IMF recommend and why? However, before answering on these ques-tions, I would to begin with a story about the role and significance of economistsin creating stable macroeconomic environment.

An economist, a philosopher, a biologist, and an architect were arguing aboutwhat was God’s real profession. The philosopher said: “Well, first and foremost, Godis a philosopher because he created the principles by which man is to live. ““Ridiculous!” said the biologist, “Before that, God created man and woman and allliving things, so clearly he was a biologist.” Wrong”, said the architect. “Before that,he created the heavens and the earth. Before the earth, there was only complete con-fusion and chaos!” “Well,” said the economist, “where do you think the chaos camefrom?”

Although it sounds funny, I beg to differ. I believe that economists world-wide do their best to make the planet a better place to live. What did they learnfrom rich and diverse experience? Have they found out some standard recipes?

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ABSTRACT: On December 20, 2000Yugoslavia was readmitted to the IMF, whichled to the approval of emergency post conflictassistance. On June 11, 2001, the ExecutiveBoard of the IMF approved a Stand-byarrangement. On May 13, 2002, theExecutive Board of the IMF approved anExtended Arrangement. In general, the IMF-supported programs are focused on the fol-lowing: (i) restrained fiscal policy; (ii) consis-tent monetary and exchange rate policies;(iii) wage and price policies; and (iv) struc-tural policy. In the period from 2001 to 2003,considerable progress was made in the cre-ation of an appropriate institutional environ-ment for the operation of a market economy.

Serbia & Montenegro is growing at rate thatare about twice as large as EU growth rate;however, after a two year period of recoveryand accelerated reforms, 2003 has seen aslowing in the rate of economic growth.Although inflation was relatively low in 2003,large imbalances continued: (i) the fiscaldeficit amounted to 4.2 percent of GDP on acash basis; (ii). the current account deficitwas 12.5 percent of GDP. Having in mindtwo potential causes of macroeconomic insta-bility, discussions between the IMF and coun-try authorities focused on the need to tightenfiscal policy to reduce the pace of domesticdemand and improve the current accountdeficit in the short run.

1. REFORM AGENDA THROUGH TIME

Reform agenda has always been subject to fashions. During the 1950s and1960s, the “big push”, planning, and import-substitution were the pillars of eco-nomic reforms in poor countries. These ideas lost ground during the 1970s tomore market-oriented views that emphasized the role of the price system andoutward-orientation. By the late 1980s it was developed a set of policy principlestermed the “Washington Consensus”. The Table shows the original list, whichfocused on fiscal discipline, “competitive” currencies, trade and financial liberal-ization, privatization and deregulation. Towards the end of the 1990s, this listwas augmented with the “good governance” policies. They ranged from anti-cor-ruption and corporate governance to social safety nets and targeted anti-povertyprograms.

The reform agenda the IMF has formulated looks very similar to the“Augmented Washington Consensus” list.

Table 1Rules of good behavior

Source: Dani Rodrik (2003)

The experience accumulated in the past decade provides support for the viewthat the most successful transition countries are those that have both stabilizedand undertaken comprehensive reforms, and that more and faster reform is bet-ter than less and slower reform. It became clear that different aspects of reformhad to be carried out at different speeds. While stabilization could be effected rel-

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The IMF supported program in Serbia & Montenegro

Original Washington Consensus:

1. Fiscal discipline

2. Reorientation of public expenditures

3. Tax reform

4. Financial liberalization

5. Unified and competitive exchange

6. Trade liberalization

7. Openness to DFI

8. Privatization

9. Deregulation

10. Secure Property Rights

"Augmented" Washington Consensus:

11. Corporate governance

12. Anti-corruption

13. Flexible labor markets

14. Adherence to WTO disciplines

15. Adherence to international financial codes and standards

16. "Prudent" capital-account opening

17. Non-intermediate exchange rate regimes

18. Independent central banks/inflation targeting

19. Social safety nets

20. Targeted poverty reduction

atively quickly, the creation of the institutions of a market economy would takemuch longer.

Inflation stabilization is one of the major success of the transition process.Upon liberalization, several measures were introduced to contain inflation: tightmonetary and credit policy, wage control policy, monetary reform, and non-inflationary sources of financing the budget deficit. The choice of exchange rateregime was an important part of the initial stabilization strategy. In most cases,using exchange rate nominal anchors, most transition countries had achievedprice stability. The countries with the currency board have had the most impres-sive inflation performance.

Privatization is a key element in the reform process. Some countries chosethe mass privatization route with the use of vouchers (Czechoslovakia andRussia), while others chose to sell enterprises (Hungary and Poland). The impo-sition of hard budgets constraints on enterprises appears to be an importantdeterminant of successful privatization. Privatized firms appear to have per-formed better than state enterprises.

Output declined in all countries in the initial year years of transition. Despitethe beginning of growth in most countries, very few countries reached their pre-transition year output levels. Relative to 1989, only Poland, the Slovak Republic,and Slovenia had higher measured output levels in 1998. It also became clear thatthe countries that that had moved faster started to grow faster.

The experience of the East Asian transition economies has been so quite dif-ferent. Most indicators suggest that progress on structural reforms in East Asiahas been relatively modest, yet output performance has been far superior to eventhe best reformers in the Central and Eastern Europe.

After the transition experience accumulated in the past decade, new reformagenda has been developed. “Washington Consensus” was dominant in thebeginning of the transition process. The new reform agenda termed “evolution-ary-institutionalist perspective” gained more support over time in light of thetransition experience. Table 2 gives a summary of those two visions. However,IMF-supported program are still based on “Washington Consensus”.

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Table 2A Simplified Presentation of the Two Different Visions of Transition

Source: Dani Rodrik (2003)

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Washington Consensus View Evolutionary-Institutionalist Perspective 1. Political economy of reforms and reform strategy

Attitude toward uncertainty

Insistence on sure efficiency gains; faith in social engineering

Insistence on sure aggregate uncertainty; skepticism toward social engineering

Political economy emphasis

Use window of opportunity to create irreversibility

Ensure continuous and growing support for reforms

View of partial reforms

Create rents that block further reform progress

Depends on sequencing: can either create momentum or stall reform process

View of reform complementarities

Of absolute importance. Necessity to jump-start the market economy by simultaneous introduction of all main reforms

Very important but comprehensiveness of initial reforms not necessary, provided initial reforms can create momentum for further reforms. Transitional institutions can develop and evolve gradually toward more perfect institutions

Main support group for reforms

Owners of privatized enterprises Middle class and new private sector

Focus of reforms Liberalization, stabilization, privatization

Create institutional underpinnings of markets to encourage strong entrepreneurial entry

Attitude toward institutional change

Emphasis on adoption of laws Comprehensive: legal and financial change, law enforcement, reform of organization of government, development of self-enforcing social norms

Attitude toward initial conditions

Create “clean state” conditions by breaking existing Communist state structure

Use existing institutions to prevent economic disruption and social unrest while developing new institutions

2. Allocative changes Main view of markets and liberalization

Markets will develop spontaneously provided government does not intervene; supply and demand as focus of analysis

Importance of institutional underpinnings need to enhance market growth: minimum legal and contractual environment, law enforcement political stability, building of business networks and long term partnerships; contracting agents and their institutional environment as unit analysis

Main attitude toward inefficient state owned enterprises

Aggressive closing down Containment and politically feasible downsizing. Rely on evolutionary development of private sector to shrink state sector

Main view of government

Weaken it as much as possible to prevent intervention in markets

Role of government in law enforcement and in securing property rights

3. Governance changes Focus of privatization

Fast transfers of ownership to private hands via mass privatization to break government power and jump-start market economy. Faith in market to ensure efficient resale

Emphasis on organic development of private sector. Emphasis on sales to outsiders to achieve efficient transfer of ownership from the start

Main emphasis of government

Main emphasis is shrinking the size of government

Reform in the organization of government so as to align as much as possible the interests of government bureaucrats with the development of markets

Hardening budget constraints

Exogenous policy choice that depends on political will

Endogenous outcome of institutional changes

2. THE ROLE OF THE IMF

The IMF is a specialized agency of the United Nations system1 set up bytreaty in 1945 to help promote the health of the world economy.

It is useful to make clear what the objectives of IMF programs are and howprograms are designed. On the objectives of IMF programs, the IMF Articles ofAgreement (Article I, “Purposes”) seems to be a reasonable starting point. Of thesix objectives listed, there are two that come closest to specifying what the IMFprograms objectives are for its member countries. The purposes of Fund pro-grams are “ to give confidence to members by making general resources of the Fundtemporarily available to them under adequate safeguards, thus providing them withopportunity to correct maladjustments in their balance of payments...” and “..toshorten the duration and lessen the degree of disequilibrium in the international bal-ance of payments.” Reading this literally, the aim of Fund programs would appearto be a narrow one—correct balance of payments disequilibria.

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Box 1

The IMF’s Main Business:Macroeconomic and Financial Sector Policies

In its oversight of the member countries’ economic policies, the IMF looksmainly at the performance of an economy as a whole. This comprises totalspending (and its major components like consumer spending and businessinvestment), output, employment, and inflation, as well as the country’s bal-ance of payments.The IMF focuses mainly on a country’s macroeconomic policies (policies relat-ing to the government’s budget, the management of money and credit, and theexchange rate-and financial sector policies, including the regulation and super-visions of banks and other financial institutions). In addition, the IMF pays dueattention to structural policies that affect macroeconomic performance, includ-ing labor market policies that affect employment and wage behavior. The IMFadvises each member on how its policies in these areas may be improved toallow the more effective pursuit of goals such as high employment, low inflation,and sustainable economic growth or growth that can be sustained without lead-ing to such difficulties as inflation and balance of payments problems.

1 The IMF membership now totals 184 countries.

Fixing the balance of payments disequilibria at the expense of all other eco-nomic goals, doesn’t seem reasonable. For example, one can imagine a situationwhere extremely tight macroeconomic policies combined with large exchangerate devaluations would turn the current account around pretty quickly butwould drastically reduce welfare and growth by compressing consumption andinvestment. Moreover, narrowly focusing on the balance of payments in Fundprograms would seem inconsistent with the Fund’s broader mandate “…to facil-itate the expansion and balanced growth of international trade, and to contributethereby to the promotion and maintenance of high levels of employment and real

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Box 2

The IMF’s Purposes

The purposes of the International Monetary Fund are:i. To promote international monetary cooperation through a permanent insti-

tution which provides the machinery for consultation and collaboration oninternational monetary problems.

ii. To facilitate the expansion and balanced growth of international trade, andto contribute thereby to the promotion and maintenance of high levels ofemployment and real income and to the development of the productivityresources of all members as primary objectives of economic policy.

iii. To promote exchange stability, to maintain orderly exchange arrange-ments among members, and to avoid competitive exchange depreciation.

iv. To assist in the establishment of a multilateral system of payments inrespect of current transactions between members and in the elimination offoreign exchange restrictions which hamper the growth of world trade.

v. To give confidence to members by making the general resources of the Fundtemporarily available to them under adequate safeguards, thus providingthem with opportunity to correct maladjustments in their balance of pay-ments without resorting to measures destructive of national or internation-al prosperity.

vi. In accordance with the above, to shorten the duration and lessen the degreeof disequilibrium in the international balances of payments of members.

The Fund shall be guided in all its policies and decisions by the purposes setforth in this Article.

From Article I of the IMF’s Articles of Agreement

income and to the development of the productive resources of all members as prima-ry objectives of economic policy” and “each member shall: (i) endeavor to ...orderlyeconomic growth with reasonable price stability...” The latest facility designed forthe low income countries, Poverty Reduction and Growth Facility, explicitlymentions growth as an objective.

To serve these purposes, the IMF: (i) monitors economic and financial devel-opments and policies and gives policy advice; (ii) lends to member countrieswith balance of payment problems, not just to provide temporary financing butto support adjustment and reform policies aimed at correcting the underlyingproblems; and (iii) provides the governments and central banks of its membercountries with technical assistance and training in several areas, including fiscalpolicy, monetary policy, and statistics.

The IMF makes its financial resources available to its members through avariety of loan programs. In addition to its regular facilities (Stand-ByArrangement (SBA), the Extended Fund Facility (EFF), the SupplementalReserve Facility (SRF), Emergency Assistance, and the Compensatory FinancialFacility (CFF)) it also provides concessional assistance under its PovertyReduction and Growth Facility (PRGF) and debt relief under the HeavilyIndebted Poor Countries (HIPC) Initiative.

The increase in the probability of IMF Program approval is shown on theFigure 1.

Source: Barro, Robert, and J.Lee (2002)

The outstanding use of Fund resources at end-December 2003 stood at SDR71.8 billion (Table 3). Under the GRA, the largest five users (Brazil, Turkey,Argentina, Indonesia, and the Russian Federation) represented 86 percent of

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total outstanding resources at end-2003, a marked increase since 1994. Serbiaand Montenegro is ranked 11th. Among PRGF-eligible countries, the top fiveusers (Pakistan, Zambia, Democratic Republic of Congo, Ghana, and Tanzania)represented about 38 percent of total outstanding PRGF loans at end-2003.

Table 3Total Fund Resources Outstanding

(top 20 countries, as of December 31, 2003)

Source: Report on Access to Fund Resources During 2003, IMF, February 2004.

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Percent of total Fund resources outstandings

Country SDR mn. Member Cumulative Country Percent of

quota GRA Resources Brazil 19,056 29.3 29.3 Turkey 1,682 Turkey 16,213 24.9 54.2 Brazil 628 Argentina 10,446 16.1 70.3 Uruguay 530 Indonesia 6,915 10.6 80.9 Argentina 493 Russian Federation 3,411 5.2 86.1 Indonesia 333 Uruguay 1,626 2.5 88.6 Liberia 282 Ukraine 1,235 1.9 90.5 Somalia 219 Philippines 806 1.2 91.8 Sudan 202 Bulgaria 799 1.2 93.0 Jordan 166 Algeria 665 1.0 94.0 Serbia and Montenegro 132 Serbia and Montenegro 617 0.9 95.0 Bulgaria 125 Pakistan 474 0.7 95.7 Philippines 92 Romania 401 0.6 96.3 Ukraine 90 Sudan 344 0.5 96.9 Ecuador 87 Jordan 284 0.4 97.3 Papa New Guinea 62 Ecuador 262 0.4 97.7 Russian Federation 57 Sri Lanka 221 0.3 98.0 Moldova 55 Liberia 201 0.3 98.3 Sri Lanka 53 Zimbabwe 118 0.2 98.5 Bosnia and Herzegovina 53 Somalia 97 0.1 98.7 Algeria 53 Total of top 20 64,191 98.7 98.7 Average 270 Total of all members 65,032 100.0 100.0 PRGF Resources Pakistan 945 13.9 13.9 Kyrgyz Republic 153 Zambia 578 8.5 22.4 Armenia 149 Congo, Dem. Rep.of 473 7.0 29.4 Tanzania 148 Ghana 305 4.5 33.9 Burkina Faso 139 Tanzania 294 4.3 38.2 Niger 134 Cote d'Ivoire 286 4.2 42.4 Chad 127 Cameroon 234 3.4 45.9 Cameroon 126 Yemen 230 3.4 49.3 Albania 125 Vietnam 227 3.3 52.6 Mozambique 124 Georgia 183 2.7 55.3 Mali 122 Senegal 161 2.4 57.7 Georgia 122 Uganda 159 2.3 60.0 Zambia 118 Nicaragua 144 2.1 62.1 Nicaragua 110 Mozambique 141 2.1 64.2 Sierra Leone 110 Armenia 137 2.0 66.2 Mauritania 109 Kyrgyz Republic 136 2.0 68.2 Senegal 100 Bolivia 123 1.8 70.0 Madagascar 95 Madagascar 116 1.7 71.8 Yemen 94 Honduras 115 1.7 73.4 Pakistan 91 Sierra Leone 114 1.7 75.1 Honduras 89 Total of top 20 5,101 75.1 75.1 Average 119 Total of all members 6,790 100.0 100.0

Credit from the IMF is generally conditional on the adoption of appropriatepolicies to resolve a country's balance of payments difficulties, contribute to strongand sustainable economic growth, and enable the government to repay the Fund.

These policies constitute a member country's "policy program", which isdescribed in a letter of intent (which may or may not have a memorandum of eco-nomic and financial policies attached to it) that accompanies the country's requestfor IMF financing.

Most IMF loans feature phased disbursements. This allows the IMF to verifythat a country is continuing to adhere to its commitments before disbursing suc-cessive installments.

Program monitoring relies on several different tools:• Prior actions are measures that a country agrees to take before the Fund's

Executive Board approves a loan and before the initial disbursementtakes place. Such measures ensure that the program has the necessaryfoundation to succeed. Prior actions could include, for example, adjust-ment of the exchange rate to a sustainable level, elimination of price con-trols, or formal approval of a government budget consistent with theprogram's fiscal framework. Prior actions for the completion of reviewsare frequently applied to structural benchmarks whose implementationhas repeatedly been delayed.

• Performance criteria (PCs) are specific conditions that are critical to thesuccess of the adjustment program and whose implementation in a spe-cific timeframe is important. They need to be defined in precise terms.Their implementation constitutes a condition for purchases under anarrangement. There are two types of PCs: quantitative and structural.Quantitative PCs typically refer to macroeconomic policy variables suchas international reserves, monetary and credit aggregates, fiscal balances,or external borrowing. For example, a program might include a mini-mum level of net international reserves, a maximum level of central banknet domestic assets, or a maximum level of government borrowing. Inarrangements where structural reforms are an essential part of the eco-nomic program, structural PCs are also used. These vary widely acrossprograms but could, for example, include specific measures to restruc-ture key sectors such as energy, reform social security systems, orimprove financial sector operations.

• Initially, conditions may be set as indicative targets when there is substan-tial uncertainty about economic trends beyond the first months of the pro-gram. As uncertainty is reduced, these targets will normally be establishedas performance criteria, with appropriate modifications as necessary.

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Box 3. Overview of Access Policy

Under the Credit Tranches, EFF, and PRGF

The current limits to Fund resources under the credit tranches and the EFFwere established in 1994. Access is limited to 100 percent of quota annuallyand 300 percent of quota cumulatively net of scheduled repurchases, but mayexceed these limits in exceptional circumstances. The Executive Board in early2003 defined policies and procedures applying to exceptional access (accessunder any facility that exceeds the limits applying to the credit tranches andEFF).Access under a PRGF arrangement is subject to a maximum limit and anexceptional maximum limit. The maximum limit is 140 percent of quota; thiscould be raised to 185 percent of quota under exceptional circumstances.Expectations on average access under initial three-year arrangements are setunder the PRGF at 90 percent of quota for first time users and 65 percent forsecond time users of the facility—each over a three-year arrangement, andthere are no specific limits for subsequent arrangements. There is no cumula-tive access limit under the PRGF.The size of access in individual cases is based on the following criteria:• Balance of payments need. The member’s actual or potential need for

resources from the Fund is considered, taking into account other sourcesof financing and the desirability of maintaining a reasonable level ofreserves; in no circumstance can access be greater than this need.

• Capacity to repay. To preserve the revolving character of Fund resources,the capacity of the member to service its indebtedness to the Fund and thetiming and extent of the expected improvement in the member’s balanceof payments are relevant factors. The strength of the member’s adjust-ment program is an important element in judging capacity to repay.

• Indebtedness to the Fund and track record. The amount of the member’soutstanding use of Fund credit and its record in using Fund resources inthe past must enter into the judgment on the appropriate scale of furtheruse of Fund financing. Consistent with this, access for member countriesthat are prolonged users of Fund resources should be determined with aview to facilitating graduation from a program relationship and, whereappropriate, greater reliance on private financing, both domestic andexternal.

• Structural benchmarks are similar to structural PCs, except that individ-ual benchmarks are less critical for meeting the program's objectives.Thus, benchmarks may help the Board assess a country's progress onstructural reforms, but failure to achieve them would not necessarilyinterrupt Fund financing. Accordingly, structural benchmarks are gener-ally not directly linked to the continuation of purchases. By contrast, per-formance criteria are conditions for the continuation of a program andrequire a waiver in the case of non-observance.

Another important monitoring tool is the program review. Program reviewsprovide a framework for assessing structural reforms against established bench-marks, or progress in implementing reforms. Reviews are used to discuss policiesand introduce changes to the program that may be necessary in light of newdevelopments. The completion of a review is linked to a purchase. Ideally, thefocus of forthcoming program reviews should be defined in letters of intent, par-ticularly if the content of the letter of intent goes beyond the policies that areimportant for the achievement of a program’s macroeconomic objectives.

When designing a program, four considerations are taken into account todetermine the appropriate monitoring tool:

1. Level of priority: PAs and PCs signal the highest level of priority; with SBsgenerally signaling a lower priority.

2. Timing: the completion of PAs should be important at the outset of anarrangement or before the completion of a review, while that of PCsshould be critical within a specific interval; the timing of SBs may bemore flexible.

3. Definability: PAs, PCs need to be very clearly defined, SBs should ideallybe clearly defined, but need not be, and review conditions may be speci-fied in more general terms.

4. The presence or absence of perverse incentives: PAs and PCs, and to a lesserextent SBs, being associated with specific dates, can put the authorities ata disadvantage in negotiations that may involve third parties.

3. THE IMF MODEL AND EMPIRICAL FRAMEWORK

Building on the monetary approach to the balance of payments, financialprogramming makes use of simple macroeconomic identities in order to linkintermediate policy targets with macroeconomic aggregates such as economicgrowth. To illustrate this approach, consider the classical money equation:

MV = PY (1)

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where M is money supply, V is the velocity, P is the aggregate price level in theeconomy, and Y is aggregate output. For a given growth, inflation and velocityprojection, the resulting transformed change in the demand for money satisfiesthe banking system balance sheet:

∆m=∆NDA+∆NFA (2)

where ∆m is change in money supply, NDA is net domestic assets, and NFA is netforeign assets. But simple accounting requires that the change in net domesticassets equals the change in net domestic credit plus the change in other items net,a term that captures miscellaneous movements in these aggregates:

∆NDA+∆NDC+∆OIN (3)

where NDC is net domestic credit and OIN is “other items, net.” In turn, thechange in domestic credit can be decomposed into the shares that go to the pri-vate and public sectors:

∆NDC=∆CPS+∆NCG (4)

where CPS is credit to the private sector and NCG is net credit to the govern-ment. The budget deficit/surplus (BD) must be financed with some combinationof domestic credit (∆NCG), non bank borrowing from the private sector(∆NBBp)and foreign sources or external financing (∆EF):

BD=∆NCG +∆NBBp +∆EF (5)

Therefore, given a balance of payment target, D NFA, and a decision on cred-it to the private sector, ∆CPS, the government’s budget deficit is largely deter-mined.

4. THE IMF IN SERBIA & MONTENEGRO

The IMF focuses on helping countries to formulate and implement policiesto avoid unstable macroeconomic developments like increasing debt, high infla-tion, high devaluation. Serbia and Montenegro survived numerous crises in the1990s, but on December 20, 2000 Yugoslavia was readmitted to the IMF, whichled to the approval of emergency post conflict assistance amounting to SDR

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116.9 million (about US$150 million).2 On June 11, 2001, the Executive Board ofthe IMF approved a Stand-by arrangement, totaling SDR 200 million (aboutUS$260 million) in four tranches, which has been fully disbursed. On May 13,2002, the Executive Board of the IMF approved an Extended Arrangement total-ing SDR 650 million (about US$860 million) for three-years in thirteen tranches.Disbursements are conditional upon implementation of an agreed program ofeconomic policies. Serbia and Montenegro drew six tranches (SDR 300 million):

• In May 2002 – SDR 50 million,• In August 2002 – SDR 50 million,• In April 2003 – SDR 100 million,• In August 2003 – SDR 100 million.Let be clear about the role of the IMF. The IMF cannot provide directly

investment, labor force, and technologies what are sine qua non of the growth.What it can do is to provide financial resources in support of appropriate eco-nomic policies to facilitate investment, employment and technological growth.The IMF also provides technical assistance and catalyzes external financial assis-tance.

In general, the IMF-supported program (and presented by the Fund’sExecutive Board in a “Letter of Intent” and Memorandum of Economic andFinancial Policy (MEFP)) is focused on the following:

• Restrained fiscal policy;• Consistent monetary and exchange rate policies;• Wage and price policies;• Structural policy.

FFiissccaall ppoolliiccyy includes:

• Measures to strengthen tax compliance;• Measures to reduce distortions and enhance transparency in tax system

and public spending;• Increased social transfers targeted toward the most vulnerable groups of

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2 The FRY met the last two of the original four conditions to succeed to the former Yugoslavia's mem-bership in the Fund, specified in the Board's 1992 Decision: (i) the clearance of about SDR 101.1 mil-lion of arrears to the Fund; and (ii) a finding by the Board that FRY is able to fulfill its obligations as amember of the Fund. Given FRY's very low external reserves, and the difficulty in securing otherfinancing, the clearance of its arrears to the Fund required a bridging loan from member countrieswhich would be repaid by resources provided by a purchase from the Fund. Norway and Switzerlandextended such a loan. Two other conditions had been met much earlier. Specifically, the FRY had:(iii) accepted its share in the assets and liabilities in the Fund, as of January 7, 1993; and (iv) agreed tosucceed pay the increased subscription. The FRY's quota in the IMF is SDR 467.7 million.

• Strict limits on the fiscal deficit and on general government borrowingfrom the banking system;

• No accumulation of arrears.

MMoonneettaarryy aanndd eexxcchhaannggee rraattee ppoolliiccyy includes::

• Reform of monetary policy instruments;• Preservation of NDA, NFA and reserve money within defined limits;• Maintaining tight credit conditions with a view to lowering inflation;• Exchange rate policy consistent with safeguarding external competitive-

ness and the foreign reserve target.

WWaaggee aanndd pprriiccee ppoolliiccyy includes:

• Wage limits in the state enterprise sector; and• Adjusting administered prices to reflect economic costs.

SSttrruuccttuurraall rreeffoorrmm ppoolliiccyy includes a range of policies relating to both the pri-vate sector and the public sector, and calls for:

• clearly defined ownership;• measures to improve the business environment.

Financial sector development is also a critical area as the financial intermedi-ation must be able to ensure the efficient allocation of savings.

Policies aimed at growth of the private sector include: privatization, propermarket regulations such as competition laws, bankruptcy laws, laws against cor-ruption and improved corporate governance.

Structural policies in the public sector include reforms to reduce waste in theprovision of public services (that is services that cannot be produced fully by theprivate sectors, such as roads, infrastructures, the legal system, education, healthservices, and so on).

4.1 EMERGENCY POST-CONFLICT ASSISTANCE

The short-term stabilization program covered the period through end-March 2001. It focused on bringing inflation under control.

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Background

At the time of approval Emergency Post Conflict Assistance, output stood atabout 40 percent of its 1989 level. Unemployment was rampant. The macroeco-nomic situation was very fragile. Consolidated cash fiscal deficit have been keptat low levels (bellow 1 percent of GDP in 2000) through a compression of realspending and accumulation of arrears. The fiscal deficit on an accrual bases hasbeen higher, at least 3 percent of GDP, even excluding servicing of governmentdebt of over 100 percent of GDP. The banking system (including the NBY) hadbeen used by the government to extend direct credits to state-owned companies,insolvent commercial banks and the agricultural sector, with a view to subsidiz-ing their operations and keeping utility and food prices low. Accordingly, thequasi-fiscal deficits of some large state enterprises have been sizable. Followingthe liberalization of prices, retail prices rose, bringing the 12-month retail priceinflation in November to 110 percent. This eroded real wages and pensionswhich stood on average at DM 90 per month. The absence of structural reformhas also contributed to the emergence of macroeconomic imbalances.

Program

The short-term stabilization program called for the tight fiscal and monetarypolicy and the introduction of a managed float with current account convertibil-ity. In the area of fiscal policy, strategy envisaged prioritization of expenditures,improvements in tax administration, and widening of tax base through elimina-tion of tax exemptions and curtailment of the gray economy. The overall fiscaldeficit was limited to the available amount of foreign grants and loans. In thearea of monetary policy, the strategy envisaged little or no bank financing of thebudget; no NBY credit expansion for other purposes; a floor on the NFA of theNBY; and the introduction of a managed float with internal convertibility toallow exchange rate to find its equilibrium value. Adherence to these credit limitsensured that monetary expansion was limited to net purchase of foreignexchange, helped bring inflation down to the low single-digits by early 2001, andstabilize the exchange rate. The import regime was liberalized, although someexport quotas remained in effect. Policy makers opted for a gradual move tomanaged float. Since October 14, all foreign transactions have taken place at theexchange rate of 30 dinars per DM (which equals the gray market rate), while theNBY played only a limited role in the interbank foreign exchange market owingto its low level of reserves. On December, exchange restrictions were abolished inthe form of obligatory sales of foreign exchange by exporters and importers at

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the official exchange rate (10 percent of the value of exports and 5 percent of thevalue of imports).

4.2 STAND-BY ARRANGEMENT

On June 11, 2001, the Executive Board of the IMF approved a Stand-byarrangement in support of a stabilization and reform program for 2001, totalingSDR 200 million (about US$260 million) in four tranches which has been fullydisbursed. The first tranch was available upon Board approval of the arrange-ment. The three-phased purchases were linked to the observance of performancecriteria at end-June, end-September and end- December 2001, and to the com-pletion by the Board of associated quarterly reviews in September 2001,December 2001, and March 2002.

Table 4Federal Republic of Yugoslavia:

Schedule of Purchases Under the Stand-By Arrangement

Source: Federal Republic of Yugoslavia: Request for a Stand-By Arrangement, IMFCountry Report, June 2001.

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Amount of Purchase In millions of SDRs In percent of quota

Conditions

June 2001 50.0 10.7 Board approval of stand-by arrangement

August 15, 2001 50.0 10.7 Observance of end-June 2001 performance criteria and completion of quarterly review

November 15, 2001 50.0 10.7 Observance of end-September 2001 performance criteria and completion of quarterly review

February 15, 2002 50.0 10.7 Observance of end-December 2001 performance criteria and completion of quarterly review

Total 200.0 42.7

Background

As a consequence of applied Emergency Post-Conflict Program, inflation hascome down sharply from 113 percent at end-2000 to 33 percent in March 2002.However, achievement of a viable balance of payment position required muchmore, prudent macroeconomic policy and bold structural reforms, but alsorestructuring of its external debt on appropriate terms.

Program

The program aimed at rapid disinflation, a viable external position and amoderate recovery in output. Real GDP was expected to grow by 5 percent in2001 and inflation to decrease by end-2001 to 30 percent. Envisaged fiscal andcurrent account deficit were 6.1 and 14.6 percent of GDP respectively. In light ofdifficult initial conditions, achieving these aims required the provision of sub-stantial debt relief and additional support from creditors and donors, as well asdifficult policy choices at home like reducing macroeconomic imbalances andadvancing economic restructuring. Under the stand-by program, the officialscommitted themselves not to contract or guarantee any new indebtedness oncommercial terms (with the exception of loans from four international financialinstitutions).

Fiscal and monetary policy imposed strict limits on credit expansion to thegovernment and the rest of the economy.

Specifically, the fiscal program for 2001 provided for: (i) strict limits on gen-eral government borrowing from the banking system to the equivalent of 0.6percent of GDP in 2001; (ii) increased social transfers targeted toward the mostvulnerable groups of the population; and a bold fiscal reform to eliminate majortax distortions and enhance transparency in spending. A large portion of invest-ment and economic restructuring programs has been explicitly identified as con-tingent on external financing. This segment of expenditures was presented at theDonor Pledging Conference in June 2001 as supplementary “budget for recoveryand reconstruction” with a view to attracting foreign financial assistance.Excluding supplementary budget, total public expenditure on consolidated basisenvisaged to reach 43.6 percent of GDP. On this basis, the overall cash deficit(before grants and privatization receipts) of the general government was project-ed to reach 3.8 percent of GDP in 2001 financed by resource to the banking sys-tem in an amount to 0.6 percent of GDP, privatization receipts of 1.4 percent ofGDP, and foreign grants and loans of 1.8 percent of GDP. The objectives of taxreform were: creating a simpler, more neutral tax system with wide tax bases,

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simple and relatively low rate structures and a minimum of “nuisance” taxes. Toimprove transparency, previous extra-budgetary programs financed by ear-marked special surtaxes have been integrated into the budget and all earmarkingof revenues in the Serbian budget have been abolished. Serbia’s budget executionsystem has been highly inefficient, contributing to a waste of public funds. Toaddress the most immediate problems, program aimed to protect expenditureson health, education, pensions, unemployment and welfare benefits to alleviatethe social effects of economic restructuring. The link between pensions andwages was replaced by indexation to combination of the cost of living and wages.Set of short-term measures improved cash management, budget reporting andcommitment control. Over the medium term, the Serbian government had anambitious agenda to improve expenditure management, including the creationof a Treasury Department. Concerning arrears, the government’s efforts focusedon avoiding the accumulation of new arrears, while allowing for a modest reduc-tion of accumulated arrears, mainly in child care benefits and farmer pensions.

Electricity tariffs were increased to cover operational costs this year, whiledonor assistance covered capital repair and maintenance costs. Additionally,Program envisaged adopting measures to strengthen financial discipline in thestate-owned enterprise sector. In cooperation with the World Bank and the man-agement of large, state-owned companies, the Serbian government formulatedrestructuring programs and established the necessary mechanisms to monitorand control revenue and expenditure developments, in particular wage costs andbank borrowing. Wage policy in the state sector aimed to keep the annual wagebill constant in real terms, which helped limit inflation, including via its demon-stration effect.

The NBY maintained tight credit conditions with a view to lowering infla-tion. Credit and money targets for 2001 were consistent with projected nomi-nal GDP growth and unchanged velocity. The assumption of unchanged veloc-ity is conservative regarding the rebuilding of confidence in dinar. Higher thanprojected NFA asked for either sterilizing the foreign exchange inflows bymaintaining NDA bellow program ceiling (supposing that NFA reflects tempo-rary and reversible factors) or) higher level of reserve money (supposingimproved confidence in the currency). Monetary policy was planed to conducton the basis of market-oriented policy instruments (like the discount rate at alevel that better reflected conditions in the money market and auctions of secu-rities in quantities sufficient to absorb the excess liquidity in the market andaccepted the resulting interest rates). Such policy is estimated to permit a relax-ation of exchange rate and trade restrictions without undue pressure on theexchange rate.

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Structural policies included further liberalization of the foreign exchange,trade, and price regimes; a radical reform of the public finances; restructuring ofthe banking system; and important steps in enterprise restructuring and privati-zation.

Banking restructuring strategy included two options: (a) bank rehabilitation,only if it is expected to produce viable bank with good prospects for privatizationor (b) bank liquidation.

Private Sector Development included: (a) implementation of a privatizationprogram designed to sell a controlling stake in enterprises with developmentpotential to strategic investors either through tenders or auctions; (b) dissolu-tion/restructuring of those large enterprises that cannot be sold in their presentcondition to extract and sell viable business lines and assets; and (c) creation of abusiness environment supportive of the private sector, by reforming the existingoppressive regulatory framework and developing institutions that will facilitateprivate enterprise operation and growth.

Key macroeconomic objectives and policies under the SBA are shown in thenext Table. They are updated after the first and second review.

Table 5Key macroeconomic objectives and policies under the SBA

Source: IMF staff estimates, according to Federal Statistic Office and NBY data

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2001

SBA 2000 original rev.1 rev2

Real GDP growth 5.0% 5.0% 5.0% 5.5%

Inflation (end period) 113.5% 30%-35% 35.0% 40.0%

Current account deficit (before grants) 7.6% 17.7% 14.8% 10.2%

Current account deficit (after grants) 4.2% 11.4% 9.3% 4.7%

Fiscal deficit (including grants) 0.9% 6.1% 4.0% 2.4%

Fiscal deficit (excluding grants) 0.9% 4.9% 2.8% 1.2%

Government credits from the banking system 0.2% 0.6% 0.8% 0.8%

NFA growth 114.8% 8.2% 20.5% 65.5%

NDA growth -56.6% 18.0% 25.1% 10.1%

Reserve money growth 91.1% 26.1% 45.6% 75.6%

Box 4 contains an assessment of structural conditionality streamlining underthe proposed program.

Preconditions/prior actions under the proposed program included:increase in average electricity tariff, approval of budget and tax reform measuresconsistent with program objectives, liberalization of the foreign trade regime andagreements with World Bank and EU on an arrears clearance plan.

The quantitative performance criteria contained: (i) quarterly ceilings onnet domestic assets of the NBY; (ii) quarterly ceilings on net credit of the bankingsystem to the consolidated general government; (iii) quarterly floors on net for-eign assets of the NBY; (iv) quarterly ceilings on the contracting or guaranteeing

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Box 4

Coverage of Structural Conditionality in the Current Program

Conditionality in the program covers:• FFiissccaall ppoolliiccyy, through (i) prior actions (parliamentary adoption of a tax

reform in Serbia; and wage freeze in the government) and (i) structuralbenchmarks ( measures in the area of tax administration and expendituremanagement). The conditionality is relevant for the macroeconomicobjective of the program, including external viability.

• FFoorreeiiggnn ttrraaddee ppoolliiccyy,, through a prior action (adoption of federal legislationto liberalize the foreign trade regime in Serbia). The conditionality ismacro-relevant, as it is intended to remove important impediments togrowth and external viability.

• EElleeccttrriicciittyy pprriicciinngg ppoolliiccyy, through a prior action and structural perfor-mance criteria. This is macro- relevant, owing to its implications for bud-get subsidies and ensuring adequate energy supplies.

• BBaannkkiinngg sseeccttoorr, through (f) a prior action (on the appointment of anadministrator of the largest bank in Montenegro) and (ii)structuralbenchmarks (formulation and implementation of a bank resolution strat-egy in Serbia). This conditionality is macro-relevant. as it is intended toremove impediments to growth (lack of financial intermediation) andmonetary policy implementation (lack of a developed money market).

• PPrriivvaattee sseeccttoorr ddeevveellooppmmeenntt, through structural benchmarks (adoption of alegal and regulatory framework for privatization in Serbia). This is macro-important, as it intended to remove impediments to growth.

by the government of non-concessional external debt; (v) quarterly ceilings onthe level of extcrna1 debt with a maturity of up to one year contracted or guaran-teed by the government; (vi) quarterly ceilings on the assumption by the govern-ment of enterprise debt to banks and guaranteeing of bank loans to enterprisesby the general government; and (vii) quarterly ceilings on the stock of externaldebt servicing arrears other than those expected to be rescheduled. In addition,there will be a continuous performance criterion on the non-accumulation ofnew external payments arrears.

The indicative targets under the proposed program included: (i) quarterlyceilings on the net domestic assets of the banking system; (ii) quarterly ceilingson changes in government arrears; and (iii) quarterly ceilings on nominal wagebills and arrears for several large loss-making state-owned companies.

Structural performance criteria under the program included a timetable foradjustments in electricity prices.

Structural benchmarks under the program included policy actions in theareas of fiscal policy, banking, and privatization.

Prior actions, structural performance criteria and structural benchmarksunder the SBA are shown in the next Table.

Table 6.Federal Republic of Yugoslavia: Stand-By Arrangement, April 2001-March 2002

Prior Actions, Structural Performance Criteria, and Structural Benchmarks

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Implementation date I Prior Actions and Preconditions for Board Consideration. 1. (Serbia) Increase in average electricity tariff (weighted by consumption) by 60 percent effective April 15, and by 40 percent on June 1, 2001.

2. (Serbia) Parliamentary approval of (a) budget for 2001 and (b) tax reform measures consistent with program objectives.

3. (Federation) Freezing of all salaries paid out of the federal budget at the January 2001 level through a government decree.

4. (Federation) Liberalization of the foreign trade regime, involving: elimination of import licensing requirements, except those on 40 tariff lines covering steel products and those necessary to enforce environmental, health, safety and national security objectives; elimination of all export licensing requirements, except those on some 30 tariff lines, cover inter alia wheat, corn, live animals, edible oil, and sugar; and reducing the maximum tariff rate to 30 percent, while lowering the simple average tariff to below 10 percent.

5. (Montenegro) Appointment of a special administrator for the largest bank, which is highly illiquid.

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Implementation date 6. (Federation) Agreement with World Bank on an arrears clearance plan.

7. (Federation) Agreement with the EU on an arrears clearance plan (regarding obligations to the EIB).

8. (Federation) Financing assurances from the Paris Club. II Structural Performance Criteria 1. (Serbia) Increase in average electricity tariff (weighted by consumption) by 40 percent.

October 1, 2001

III Structural Benchmarks A. Fiscal Sector 1. (Serbia) Redesign of the co-payment system in the health care sector, with a view to generating additional revenue of YUD 0.8-1.0 billion on an annual basis.

end-May 2001

2. (Montenegro) Adoption of an organic budget system law to standardize budget classification and implementation of a centralized treasury system.

end-June 2001

3. (Serbia) Issuance of decree revising the list of drugs offered to the general public population in state pharmacies, to bring expenditures on drugs in line with financial resources available to the health care system.

end-June 2001

4. (Serbia) Improvement of cash management and fiscal reporting by eliminating primary budget managers’ expenditure accounts and own accounts of direct spending units (637 accounts and their 850 subaccounts) and by creating ledger accounts within account 630.

end-September 2001

5. (Montenegro) De-linking of the statutory minimum wage from public sector pay and social benefits levels.

end-September 2001

6. (Serbia) Establishment of a Central Accounting Division and the Treasury’s Central Accounting Division.

end-December 2001

7. (Serbia) Establishment of a new system of commitment control based in the Treasury’s Central Accounting Division.

end-December 2001

8. (Serbia) Set up of Large Taxpayer office in Belgrade end-December 2001 B. Financial Sector 1. (Federation) Adoption of a strategy for bank restructuring, in consultation with the Fund and the World Bank.

May 15, 2001

2. (Federation) Intervention of the six largest, illiquid, banks in Serbia.

end-June 2001

C. Private Sector 1. (Serbia) Parliamentary approval of privatization legislation in Serbia, designed in cooperation with the World Bank to: (a) attract investment capital by offering at least 70 percent of enterprise shares to investors and no privilege to company management, workers, or any other agents regarding purchase of these shares; (b) create, through dominant ownership, a clear ownership structure conductive to efficient resource allocation and good enterprise management; (c) facilitate failed enterprise liquidation/work-outs prior to privatization, among other things by authorizing the Privatization Agency to require an enterprise to enter workout/liquidation;

end-June 2001

Source: Federal Republic of Yugoslavia: Request for a Stand-By Arrangement,IMF Country Report, June 2001.

According to the first and second review, revised performance criteria,indicative targets and structural benchmarks were proposed (see Appendix I).Finally, according to third review, virtually all the envisaged structural measureswere implemented on time.

Table 7.Federal Republic of Yugoslavia: Stand-By Arrangement May 2001-March 2002

Remaining Structural Benchmarks

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q(d) establish transparent and efficient privatization procedures; legislation to include Law on Privatization, Law on Shares, Law on Agency of Privatization, Ordinance on Privatization Program, Ordinance on Public Tender, Ordinance on Auctions, ordinance on Business Valuation, and Ordinance on Appraisers.. 2. (Serbia) Conclusion of at least six contracts for the privatization of either large companies or pools of six companies each with investment banks hired through competitive international tenders (out of a total of four large companies and five pools).

End-October 2001

3. (Serbia) Offer of at least one company or pool of six companies for sale observing well defined, internationally accepted tender rules.

End-December 2001

Implementation Date Revised Implementation Date

III Structural Benchmarks A. Fiscal Sector 1. (Serbia) Submission of the Organic Budget Law and Public Procurement Law to parliament.

end-December 2001 Implemented




end-December 2001 …



5. (Serbia) Set up of Large Taxpayer office in Belgrade

end-December 2001 end-June

6. (Federation and Serbia) Adoption of pension reform legislation, providing for an immediate increase in retirement age by 3 years and indexation of pension to the arithmetic average of price and wage increase.


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7. (Serbia) Submission of the Tobacco Law, and Lottery Law to parliament.

end-January 2002 Implemented

8. (Serbia) Submission of a new law on tax assessment and collection to parliament

mid-February 2002 end-June 2002

B. Financial Sector Implemented 1. (Montenegro) The CBM will decide on the resolution (liquidation, rehabilitation, mergers, no action) of all banks.

mid-December, 2001 Implemented

2. (Federation) The NBY will take a decision: (i) to address the accounting treatment of unresolved succession issues, (ii) for financial year 2001, to prepare financial statements on the basis of International Accounting Standards (IAS), and (iii) to adopt IAS as its permanent accounting framework, effective with the 2003 financial years.


3. (Federation) The Internal Audit Department of the NBY, as part of its regular audit cycle, will review the reconciliation of the accounting records and the NFA data submitted to the Fund for program purposes on a monthly basis, effective with the end-December 2001 data. In addition, the NBY will strengthen the functioning of the Internal Audit Department by: (i) defining its role with the development of a charter and ensuring an appropriate degree of independence and objectivity; (ii) continuing to recruit additional staff with skill levels necessary to successfully conduct financial and information system risk-based audits; and (iii) commissioning an independent assessment of the International Audit Department.

mid-February 2002 Implemented

C. Private Sector 1. (Serbia) Conclusion of at least four contracts for the privatization of pools of companies (of 3-5 enterprise each) with investment banks hired through competitive international tenders (out of a total of seven pools for which international advisors will be solicited this year).


2. (Federation and Serbia) Request for the opinion of the Supreme Court on a draft memorandum of understanding between the Privatization Agency and Bank Restructuring Agency.


3. (Serbia) Adoption of a new labor law to liberalize the labor market.


4. (Serbia) Appoint advisors for the privatization of 2 pools comprising a total of 12 companies

January 15, 2002 Implemented

5. (Serbia) Offer at least one pools of companies consisting of 3-5 enterprises for sale observing well defined, internationally accepted tender rules.

end-February 2002 …

6. (Serbia) Offer at least two pools of companies consisting of 3-5 enterprises for sale observing well defined, internationally accepted tender rules.

end-March 2002 …

Source: Federal Republic of Yugoslavia: Staff Report for the 2002 Article IVConsultation, Third Review Under the Stand-By Arrangement and Request for anExtended Arrangement, IMF, April 2002

4.3 EXTENDED ARRANGEMENT

On May 13, 2002, the Executive Board of the IMF approved an ExtendedArrangement totaling SDR 650 million (about US$860 million) for three-yearsin thirteen tranches. Disbursements are conditional upon implementation of anagreed program of economic policies. Serbia and Montenegro drew six tranches(SDR 300 million) instead of SDR 450 million indicating that IMF is not fulfilledwith macroeconomic and structural policy.

Table 8Federal Republic of Yugoslavia:

Schedule of Purchases Under the Extended Arrangement

Source: Federal Republic of Yugoslavia: Staff Report for the 2002 Article IVConsultation, Third Review Under the Stand-By Arrangement and Request for anExtended Arrangement, IMF, April 2002.

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Amount of Purchase In millions of SDRs In percent of quota

Conditions

April 15, 2002 50.0 10.7 Board approval of the Extended Arrangement August 15, 2002 50.0 10.7 Observance of end-June 2002 performance criteria. November 15, 2002 50.0 10.7 Observance of end-September 2002 performance

criteria and completion of semi-annual review. February 15, 2003 50.0 10.7 Observance of end-December 2002 performance

criteria. May 15, 2003 50.0 10.7 Observance of end-March 2003 performance

criteria and completion of semi-annual review. August 15, 2003 50.0 10.7 Observance of end-June 2003 performance criteria. November 15, 2003 50.0 10.7 Observance of end-September 2003 performance



criteria and completion of semi-annual review. August 15, 2004 50.0 10.7 Observance of end-June 2004 performance criteria. November 15, 2004 50.0 10.7 Observance of end-September 2004 performance



criteria and completion of semi-annual review. Total 650.0 139.0

Background

In 2001, the first year of economic reform, economic performance wasimpressive: inflation declined; real GDP grew by about 5.5 percent; the currentaccount deficit (before grants) of US$1.2 billion (10.9 percent of GDP) was lowerthan projected; the foreign exchange reserves of the NBY more than doubled toUS$1.2 billion (2.6 months of import cover); the fiscal deficit was contained to1.3 percent of GDP in 2001 as a result of revenue overperformance and spendingcompression against an original program target of 6.1 percent with borrowingfrom the banking system limited to 0.7 percent of GDP. Structural reforms hasproceeded rapidly: the four largest insolvent banks (accounting for almost 60percent of the book value of the banking system assets but less than 20 percent ofbanking service) has been closed and privatization process began with the sale ofthree cement factories to foreign investors. External position has improved bythe Paris Club decision to reduce the NPV of debt to official bilateral creditors by66 percent in two phases. Additionally, in June 2001 a donor conference generat-ed pledges of US$1.3 billion.

Program

According to original program, the economic objectives for 2003-2005 areconsistent with the achievement of sustainable growth, low inflation, and aviable external position (Table 9).

• Real GDP was projected to grow by 4 percent in 2002 reflecting increasedforeign assistance, inflow of FDI, and the response of economy to improvedincentives. Beyond this, the medium-term growth rates were expected toincrease to about 5 percent as a result of implementation of reforms and aprojected rise in the level and efficiency of domestic investment.

• Inflation was targeted to be 20 percent by end-2002 which correspondedto core inflation rate of about 10 percent after accounting for furtherlarge adjustments in administered prices; to 12 percent by end-2003; and8 percent by end-2004. Over the medium term, inflation was projected toconverge toward EU levels.

• The external current account deficit was expected to widen to US$1.6billion (12.9 percent of GDP) in 2002 reflecting a resumption in externaldebt service as well as higher imports and, beyond this to narrow to 8.8percent of GDP in 2005.

• Official foreign reserves were targeted to rise steadily to the equivalentof 4.5 months of imports of goods and services by end-2005, ensuring a

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strong external position in anticipation of a peak in debt servicing oblig-ations in the second half of the decade.

• The fiscal deficit was targeted to decrease from 5.7 percent of GDP in2002 to 4.2 percent of GDP in 2005, with a view to containing the exter-nal current account deficit and supporting disinflation. Deficit was pre-dicted to finance largely by concessional foreign assistance and privatiza-tion proceeds, with no recourse to domestic financing except for season-al budgetary needs.

Fiscal policy aimed to contain the external imbalance, while continuing tosupport restructuring and an adequate social safety net. The overall expendi-ture/GDP which was projected to reach 48.5 percent in 2002 was targeted todecline by about 3 percent of GDP over the EA period while making room forincreased capital spending. On the expenditure side, fiscal policy focused on:introduction of a Treasury to improve financial control, redirection of supportaway from enterprises subsidies toward enterprise restructuring and a well-tar-geted social safety net. Noninterest current spending was expected to controlthrough structural reforms in the budgetary and enterprise sectors--involvingthe streamlining of the civil service as well as limiting spending on subsidies, dis-ability pensions, and other social benefits, while capital spending was planned torise, reflecting increased budget allocations and accelerated implementation offoreign-financed projects. On the revenue side, the focus was on improving taxadministration and bringing an increasing share of private activity into the for-mal sector. As a result, the overall fiscal deficit was projected to decrease by 1.1percent of GDP.

Wage policy in the state sector (government and major state enterprises)continued to serve as an inflation anchor and as a means of encouraging astreamlining of employment to raise productivity. Wage restraint in state enter-prises has a strong signaling effect for the remainder of the economy. Privatecompanies are already facing a hard budget constraint, while new labor laws inboth Serbia and Montenegro stipulate lower compulsory severance pay, as wellas liberalized employment contracts and wage determination.

Full recovery level of the electricity price was expected to be reached by 2004.Monetary policy continued to be guided by the same principles as in the pre-

vious period. Reserve money growth was envisaged to be driven by increases inNFA arising from foreign exchange inflows and a portfolio shift in the domesticcurrency by residents, while NDA continued to be strictly limited.

Most of the remaining trade barriers were planned to be removed during theEA period. Besides fully harmonizing trade relations between Serbia andMontenegro, free trade agreements should be signed with neighboring countries.

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The closure of the four large insolvent banks represented major progresstoward cleaning up the banking system. The next steps in bank reform involvedthe bank restructuring and privatization measures. The strengthening of banksupervision and strict enforcement of prudential rules and regulations comple-mented the bank restructuring measures.

To ensure transparency in the privatization and restructuring process, allprivatization proceeds was expected to channel to the budget and spending willfollow normal budgetary procedures. An important feature of privatization waslimitations on shares provided to insiders including workers, thus making themajority of shares available for strategic investors and support for restructuringand privatization through a flexible labor law and a supportive social policy. Theproblems of socially and state-owned enterprises, were addressed through the:privatization of entire companies, reorganization of some companies prior toprivatization, liquidation, leading to sales of assets, extraction of viable businesslines from failing firms.

Key macroeconomic objectives and policies under the EA are shown in thenext Table.

Table 9Key Macroeconomic Objectives and Policies, 2000-2005

Source: IMF staff estimates

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2000 2001 2002 2003 2004 2005 Prog. Prel.Est. Proj. Proj. Proj. Proj. (Percentage change) Real GDP growth 5.0 5.0 5.5 4.0 5.0 5.0 5.0 Agriculture -13.0 23.3 Non-agriculture 9.2 1.9 4.9 Inflation (end-period) 113.5 35.0 39.0 20.0 12.0 8.0 7.0 Of which: Montenegro 6.5 24.0 12.0 6 5 4 (In percent of GDP) Domestic investment 14.5 18.3 13.5 15.4 17.6 19.2 20.5 Domestic savings -3.5 -3.5 -8.6 -6.4 -3.4 -0.2 2.6 National savings 10.3 7 8.0 7.2 8.1 10.4 13.6 (In billions of US$) Current account deficit (before grants) US$ billion 0.6 1.5 1.2 1.6 1.7 1.6 1.4 In percent of GDP 7.6 14.6 10.9 12.8 12.4 10.7 8.8 Excluding net interest payments (percent of GDP) 7.0 12.6 10.2 9.8 9.0 7.3 5.7 Gross official reserves 0.5 0.7 1.2 1.6 2.0 2.5 2.9 In months of projected imports 1.2 1.5 2.4 3.0 3.5 3.9 4.2 (In percent of GDP) Fiscal deficit 0.9 6.1 1.3 5.7 5.3 4.8 4.2 Government credit from the banking system 0.2 0.6 0.7 0.5 0.5 0.5 0.4 (In percent of year-beginning reserve money) NFA growth 147.7 8.2 86.8 25.2 NDA growth -56.6 18 2.3 12.2 Reserve money growth 91.1 26.1 89.0 37.4

However, objectives and policies were updated in the first and second review.Table 10 shows their changes.

Table 10.Key Macroeconomic Objectives, 2002-2005.

Source: IMF staff estimates

Updated macroeconomic objectives included: lower growth rates, lowerinflation, higher current account, but lower fiscal deficit. Prior actions, structur-al performance criteria and structural benchmarks under the EA are shown inthe next Table.

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EA 2002 2003 2004 2005 Real GDP growth 4.0 5.0 5.0 5.0 Inflation (end period) 20.0 12.0 8.0 7.0 Current account deficit (before grants) 12.8 12.4 10.7 8.7 Current account deficit (after grants) Gross official reserves (in months of imports) 3.0 3.5 3.9 4.2 Fiscal deficit (including grants) 5.7 5.3 4.8 4.2 Fiscal deficit (excluding grants) Government credits 0.5 0.5 0.5 0.4 EA - First Review 2002 2003 2004 2005 Real GDP growth 3.5-4 3.5-4 5.0 5.0 Inflation (end period) 14.0 9-11 7.0 5.0 Current account deficit (before grants) 12.8 11.0 9.4 7.9 Current account deficit (after grants) 8.9 8.9 7.9 6.5 Gross official reserves (in months of imports) 3.4 3.8 4.1 4.4 Fiscal deficit (including grants) 5.0 4.5 4.3 3.9 Fiscal deficit (excluding grants) 4.2 3.1 3.0 2.7 Government credits -0.4 0.0 0.6 0.9 EA - Second Review 2002 2003 2004 2005 Real GDP growth 3.5-4 3.5-4.5 4.0 4.5 Inflation (end period) 14.0 9-11 7.0 5.0 Current account deficit (before grants) 12.8 10.9 10.2 8.9 Current account deficit (after grants) 8.8 8.5 8.8 7.4 Gross official reserves (in months of imports) 3.2 3.7 3.8 4.0 Fiscal deficit (including grants) 4.5 4.5 4.3 3.9 Fiscal deficit (excluding grants) 3.7 3.5 3.0 2.7 Government credits -0.4 0.0 0.5 0.8 EA - Current Status 2002 2003 2004 2005 Real GDP growth 4.0 3.0 4.0 4.0 Inflation (end period) 14.2 7.8 8.0 5.0 Current account deficit (before grants) 12.8 12.6 11.2 10.4 Current account deficit (after grants) 8.8 10.2 9.8 8.9 Gross official reserves (in months of imports) 3.2 4.4 4.3 4.7 Fiscal deficit (including grants) 4.8 5.7 4.6 3.9 Fiscal deficit (excluding grants) 4.0 4.7 3.3 2.7 Government credits -0.4 0.0 0.5 0.8

Table 11.Federal Republic of Yugoslavia: Extended Arrangement, March 2002-March 2005Prior Actions, Structural Performance Criteria, and Structural Benchmarks,

March 2002-March 2003

Source: Federal Republic of Yugoslavia: Staff Report for the 2002 Article IVConsultation, Third Review Under the Stand-By Arrangement and Request for anExtended Arrangement, IMF, April 2002

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Implementation Date I Prior Actions and Preconditions for Board Consideration. Federation: Submission to federal Parliament of proposed new Foreign Exchange Law and completion of draft implementing regulations consistent with the key principles described in the MEFP of April 26, 2002.

II Structural Performance Criteria Serbia: Increase electricity price by 50 percent on average end-June 2002 Federation: Effective January 1, 2003, permit commercial banks to initiate and settle payments among themselves on behalf of enterprises and individuals without the mandatory intermediation of ZOP.

end-December 2002

III Structural Benchmarks A. Fiscal Sector 1. Serbia: Establish a Large Taxpayers Unit in the Belgrade Office. end-June 2002 2. Serbia: Adopt the Law on Tax Administration organization and the Law on Identification, Control and Payment of Public Revenue

end-June 2002

3. Serbia: Establish a Treasury in the Ministry of Finance with basic core functions in cash and debt management.

end-September 2002

4. Serbia: Create a unified taxpayer identification number. end-December 2002 5. Montenegro: Adopt a pension law that shifts pension indexation to the Swiss formula (arithmetic average of wage and price increases) and raises the minimum retirement age by 3 to 5 years in a phased manner.

end-December 2002

B. Financial Sector 1. Montenegro: Adopt legislation to empower CBM to supervise the existing offshore banks in line with the rules and regulations applicable to onshore banks.

end-April 2002

2. Montenegro: Adopt final decision on the resolution of Montenegro Banka and Jugobanka ad Podgorica, as well as Beranska Banka that is yet to be re-licensed without direct or indirect fiscal resources except for appropriate social programs.

end-May 2002

3. Federation: Adopt a new Law on the National Bank of Yugoslavia to provide for a NBY Supervisory Board and amend the Law on Banks and Other Financial Institutions and establish a regulatory framework in line with international standards.

end-June 2002

4. Federation: Publish IAS-based financial statements of the NBY. end-June 2002 5. Federation: Submit draft Law on Securities Market to Parliament. end-June 2002 6. Federation: Decide on (a) privatization plans for banks under NBY enhanced supervision and administration and (b) resolution plans for banks under control of the BRA.

end-June 2002

7. Federation: Amend the Accounting Law to adopt IAS as the permanent accounting framework of all financial institutions, including the NBY.

end-September 2002

According to the first and second review, revised performance criteria,indicative targets and structural benchmarks were proposed (see Appendix II).Finally, current status shows that a lot of the envisaged structural measures arenot implemented on time.

Table 12Federal Republic of Yugoslavia: Extended Arrangement, March 2002-March 2005Prior Actions, Structural Performance Criteria, and Structural Benchmarks,

January December 2004(current status)

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Implementation Date I Prior Actions and Preconditions for Board Consideration. 1. Serbia, Montenegro: Parliamentary approval of Serbian and Montenegrin budgets (including binding provisions for Union level expenditures and the cost of bank recapitalization) for 2004 consistent with the MEFP

2. Serbia: Government approval of a resolution plan in line with the MEFP for the largest bank in Serbia

II Structural Performance Criteria 1. Serbia: Effective July 1, 2004, increase electricity price by at least 10 percent from the level prevailing at end-2003.

end-June 2004

2. Serbia: Parliamentary adoption of bankruptcy law in line with MEFP end-June 2004 II Structural Benchmarks A. Fiscal Sector 1. Serbia: Implement a centralized payroll system under the Central Accounting Division of the Treasury

end-June 2004

2. Serbia: Submit to Parliament the Law on VAT establishing a single-rate, broad-based VAT effective from January 1, 2005.

end-June 2004

3.Montenegro: Gradually transfer all government deposits in commercial banks to single treasury account in CBM.

end-December 2004

B. Financial Sector 1. Serbia: Adopt a time-bound strategy to recover value of non-performing assets of closed banks and those associated with Paris and London Club.

end-June 2004

2. Serbia: Complete the conversion of all Paris and London Club as well as FFCD-related liabilities into state-owned equity in affected banks.

end-June 2004

3. Serbia: Offer majority or controlling stakes to strategic investors in one of the banks affected by the July 2002 laws on Paris and London Club debt and frozen foreign currency deposits.

end-May 2004

4. Serbia: Offer majority or controlling stakes to strategic investors in two additional banks affected by the July 2002 laws on Paris and London Club debt and frozen foreign currency deposits.

end-September 2004

5. Serbia: Begin recovering value from impaired assets acquired by the state by selling the 25 largest corporate and commercial loans not prescribed (non-public, not on privatization list, not bankrupt) that are managed by the BRA.

end-September 2004

6. Serbia: Offer majority or controlling stakes to strategic investors in three additional banks affected by the July 2002 laws on Paris and London Club debt and frozen foreign currency deposits.

end-December 2004

7. Serbia: Conduct the sale of the second batch of non-prescribed loans that are managed by BRA.

end-December 2004

8. Montenegro: Contract out through tenders the collection of carved-out assets from the banking system.

end-September 2004

9. Montenegro: launch a transparent international tender to sell the state’s holdings in Podgoricka Banka to maximize cash privatization proceeds.

end-December 2004

5. ECONOMIC POLICY AND REFORM: RECENT DEVELOPMENTS

5.1 COMPARATIVE ANALYSIS OF STRUCTURAL REFORM STATUS

In the period from 2001 to 2003, considerable progress was made in the cre-ation of an appropriate institutional environment for the operation of a marketeconomy. The above statement is corroborated by the EBRD’s assessment thatSerbia made the greatest progress in the implementation of reform over the peri-od. Next table provides a way of confronting the progress made in the structuralreform area by the various transition countries. The table reports a set of transi-tion indicators that the EBRD has prepared for several years. They relate todegree of price and trade liberalization, privatization, advancement in enterprisegovernance, infrastructures and development of financial institutions. Theseindexes range from 1 to 4 + (reported in the table as 4.33), where the latter is themore advanced stage of private market development. The first column of thetable reports the average of the indexes and the figure shows rank of the transi-tion countries according to this index.

Table 13Structural Reform Status

Source: EBRD, Transition Report 2003

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Figure 2 Structural Reform Status

Serbian average is still relatively low (2.43) relative to 3 points threshold, wellbelow Hungary (3.84), below where Hungary was 5 years ago (3.69), belowwhere Hungary was 10 years ago (2.50).

We get similar indications on the relative position of the transition countriesfrom the corruption perception index. This index ranges between 10 (highlyclean) to 0 (highly corrupt).

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Figure 3 Corruption Perception Index

Source: Transparency International , 2003 Corruption Perception Index

We see that Serbia fairs poorly (index of 2.3) with respect to Slovenia (5.9),Estonia (5.5), Hungary (4.8) and Lithuania (4.7). Corruption is an obstacle toinvestment and the development of the business climate. However, according tothe next Figure, there has been the greatest progress in Serbia the last three years(almost 1 point). In sum, progress has been made but a lot remains to be done.

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Figure 4 Progress in Transition

Source: on the basis of EBRD, Transition Report 2003

The most significant progress was made in the: (i) liberalization of economicactivities (prices, foreign trade, the labor market, bank credit policy); (ii) privati-zation of socially owned enterprises; (iii) fiscal sector reform (system-relatedlaws, such as the organic budget law, the law on tax procedures and tax adminis-tration, laws on reform of the tax system, and reform of the pension system andsocial welfare); the reform of the banking sector (elimination of insolvent banks,strengthening supervision, transfer of the payment system into banks, etc.). Incertain fields, however, progress was relatively moderate, particularly: (i) restruc-turing public and large socially owned enterprises; (ii) public spending reform(reprioritization and reduction of expenditure); and (iii) development of thenon-bank financial sector.

5.2 INTERNATIONAL STATUS

After democratic change in late 2000, a process of FRY’s reintegration intothe international community commenced. In 2001 FRY regularized its member-ship of the UN, the IMF, the World Bank, the EBRD and other internationalfinancial organizations. Since early 2001 Serbia has cooperated with the World

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Bank, the EBRD, the EIB, with a view to implementing infrastructure projectsand reform.

In mid-2001 a donor conference for FRY was held, at which resources werepledged in the form of foreign grants and concessional loans in the amount ofaround US$ 1.3 billion. The second donor conference for Serbia andMontenegro3 was held in November 2003.

In the course of 2001 FRY regularized, i.e. rescheduled, most of its foreigndebt. Debts to IFIs were regularized immediately after the accession to member-ship, while the debts to the Paris Club were rescheduled in late 2001, under theNaples terms (a 66 percent write-off in two phases). The first phase (51 percent)entered into force with the approval of the EA, while the second phase (theremaining 15 percent) will become effective upon successful completition ofthe EA. In early 2002, the first negotiations on the rescheduling of debts to theLondon Club of creditors were held, but it is still unclear when these negotia-tions will be concluded and what their outcome will be. According to someassessments, an agreement on the regularization of debts with the London Clubcould be signed in the first half of 2004. It is expected that debt restructuringnegotiations with other official bilateral and London Club be similar to thosein the Paris Club agreement. The regularization of the relations with theLondon Club is a necessary precondition for Serbia’s inclusion into the interna-tional capital market.

In late June 2001 South East European countries (FRY-Serbia andMontenegro, Macedonia, Bulgaria, Albania, Romania, Bosnia and Herzegovina,Croatia, Hungary and Slovenia) agreed on a Memorandum under which theywere to sign bilateral agreements on free trade by the end of 2002. In 2002 FRYsigned and ratified free trade agreements with Bosnia and Herzegovina andHungary and signed an agreement with Croatia. FRY has also initialed free tradeagreements with Albania, Bulgaria, Romania, Slovenia and Moldavia and hadearlier signed a free trade agreement with FYR Macedonia. FRY is expected tosign and ratify by end-2004 free trade agreements with all the countries signato-ries of the said Memorandum. The formation of a free trade zone in early 2004 inthe southeast of Europe will create a market of around 55 million people Withthe creation of the free trade zone all the countries in the region will becomemore attractive for FDIs. In addition, in 2001 a Free Trade Agreement betweenFRY and Russia entered into force. Although the agreement with Russia providesfor certain exceptions, the assessment is that it considerably increases exportopportunities for goods produced in Serbia and Montenegro. The expectations

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3 Until March 2003 the joint state of Serbia and Montenegro was called FRY, and after that the StateUnion Serbia and Montenegro.

are that negotiations will start in the first half of 2004 on the accession of Serbiaand Montenegro to the World Trade Organization (WTO).

In the first quarter of 2003 the State Union Serbia and Montenegro was con-stituted. In late March 2003, the State Union Serbia and Montenegro was admit-ted to the Council of Europe. In early September 2003, the drafting of the feasi-bility study began, which will define conditions and time limits for accession tothe EU. The completion of the Study is expected by end-March 2004, but posi-tive assessment depends critically on the establishment of a single marketbetween Serbia and Montenegro (harmonization of tariffs, functioning of thejoint customs office, etc.) If the relations between Serbia and Montenegro areregularized in line with the EU recommendations a positive assessment withinthe Study can be expected, as well as the signing of a Stabilization andAssociation Agreement in late 2004 or early 2005. According to the prevailingassessments, Serbia and Montenegro could become an EU member around 2010.A tentative schedule for Serbia and Montenegro’s accession to the EU deter-mines to a considerable extent the contents and pace of reform in all fields.

5.3 ECONOMIC POLICY

Immediately after the constitution of the democratic government, a stabi-lization program was applied in Serbia and radical economic reform waslaunched. Fiscal and quasi-fiscal deficits were very soon put under control, andprices and the exchange rate were stabilized.

Monetary and Exchange Rate Policy

Monetary policy of the NBS, in coordination with fiscal policy, has under-pinned exchange rate stability, as well as the downward trend in inflation sinceearly 2001. In the first half of 2001, all money creation took place through opera-tions on the foreign exchange market, which implies that policy, de facto, emulateda currency board. From August 2001, the NBS approved loans to cover the Serbianbudget deficit in accordance with strict limits under the IMF-supported program.Despite the fact that the NBS has been covering a limited part of the fiscal deficitsince August 2001, the foundations of stability of the exchange rate and prices aresolid: official gross reserves reached $3.6 billion at the end of 2003 (4.4 months ofprojected 2004 imports).The NBS Law adopted in late July 2003 implies significantchanges in the conduct of monetary policy. In accordance with the Law, monetarypolicy is implemented primarily through indirect instruments such as open mar-ket operations and interest rate policy. Direct credit to the state and banks from theNBS is possible only on a temporary basis and to a limited extent.

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Although since early 2001 a policy of managed float of the dinar has beenimplemented, until the beginning of 2002 the exchange rate was de facto fixed.The policy served primarily an anti-inflationary objective, in which the exchangerate had the role of a nominal anchor. Since early 2002, exchange rate policyadapted to developments in the balance of payments, which resulted in greaterfluctuations of the rate, and a moderate depreciation of the dinar against theeuro. In late April 2002, a new Foreign Exchange Law was adopted, which furtherliberalized the foreign exchange market. The adoption of a new foreign exchangelaw, following which the authorities accepted Article VIII of the Fund's Articlesof Agreement, has contributed to a deepening of the foreign exchange market,which nevertheless remains relatively thin. One of the two remaining restrictionssubject to approval under Article VIII (Sections 2, 3 and 4)--pertaining to thetransfer of profits abroad--was eliminated through an amendment of the Law onForeign Investment in December 2002. The elimination of restrictions regardingthe transfer of profit is of particular importance from the point of view ofencouraging foreign investment. Certain restrictions were maintained as regardscapital transactions.

Fiscal Policy and Reform

The first stage of the reform of the tax system was carried out in 2001 andmajor distortions were eliminated. The major changes were in the area of retailsales tax, excises, salary tax and social security contributions. The simplificationof the tax system, i.e. the reduction of the number of fiscal instruments and theincrease in transparency, was the first course of changes. These measures includ-ed: (i) elimination of various earmarked levies which burden excised products,followed by the simultaneous increase of excises rates; (ii) reduction of a numberof turnover tax rates from seven to one; i.e. single rate final-stage tax of 17 per-cent plus 3 percent has been introduced with only a few exemptions. The secondcourse of changes was widening of tax basis: (i) specifically, tax exemptions wereradically limited regarding retail sale tax (bread and standard EU exceptions);(ii) tax base for personal income tax and social security contributions have beenbroadened to include cash benefits paid by employees. The third course ofchanges was reducing excessive tax burden on net wages; deficit in the socialsecurity system was covered via general grants from the budget; The fourthcourse of changes refers to reducing shadow economy and corruption. In 2002,the second stage of the tax reform was carried out, with the primary objective ofimproving the environment for foreign investment. In line with this objective,the corporate income tax rate was reduced from 20 percent to 14 percent. In

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2002, the rate of the highly distortionary financial transactions tax was loweredby one third and exemptions from this tax were widened. In late 2003, theSerbian Government submitted to Parliament a set of laws for the third stage ofthe tax reform, but they have not yet been adopted. In parallel with tax reform,since early 2001 important changes have been launched in the sphere of publicconsumption. With the adoption of the Organic Budget Law and the Law onPublic Procurement in 2002, institutional conditions have been created for sys-tem-related changes in public spending. The Organic Budget Law introduces aframework to plan public revenue, expenditure, the deficit and borrowing forseveral years in advance, with a view to securing the long-term sustainability offiscal policy, as well as harmonizing the change in the structure of public expen-diture with economic and social priorities. In 2001, the process of restructuringpublic spending toward reducing expenditure for security-related purposes andincreasing expenditure for social and reform-related purposes commenced. In2002-2003 period, a rise in capital expenditure, restructuring costs and publicdebt servicing costs was recorded. With the raising of retirement age for 3 years,tightening conditions for early retirement and changing the indexation rule forpensions, the first stage of the pension system reform was carried out. Thereform carried out in the pension system is essential to long-term sustainabilityof fiscal policy in Serbia.

Foreign Trade Policy

In the first half of 2001, significant reform of the foreign trade regime wascarried out: quantitative restrictions were virtually eliminated, while the tariffrate bands and the number of tariff lines were decreased. The degree of customsprotection is still high relative to neighboring countries and a gradual reductionin tariffs is expected in the coming years. During 2002, free trade agreementswith Bosnia and Herzegovina and Hungary were ratified. The signing and ratifi-cation of similar agreements with other countries in the region is expected totake place by the end of 2004. Similarly, in late 2003, Serbia and Montenegro wasgranted Most Favored Nation (MFN) status in trade with the USA.

Wage and Price Policies

Since late 2000, the prices of goods and services in Serbia have been setfreely. The exceptions are prices in infrastructure, mainly in monopolies, whichare still under state control. Since early 2001, the prices of electricity, utility ser-vices, railroad services, PTT and land line phone services have been raised sig-

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nificantly so that they are close to their cost-recovery levels. Wages in privateand the remaining socially owned enterprises are set freely, while the develop-ments with respect to wages and salaries financed out of fiscal sources, as wellthe wages in public enterprises, are under the control of the State. Despite somewage restraint, particularly in the public sector, the average net real wage growthin 2003 of 13 percent had negative implications for the competitiveness ofSerbian economy.

Social Policy

The social welfare system in Serbia was set up generously, covering a largenumber of beneficiaries (children, mothers with children, the unemployed, thepoor, refugees, etc.) and providing different forms of social protection. The enti-tlements of social protection beneficiaries, though low per beneficiary, are dis-proportionately expensive relative to the capacity to finance them. In 2001,reform of the social welfare system was launched, aimed to bring the entire socialwelfare system in line with the capacity to pay for it. To that effect, the indexationrules were changed and a methodology put in place for better targeting of benefi-ciaries. From the standpoint of implementation of economic reform, it is partic-ularly important to make adequate provisions for workers who become jobless asa consequence of the restructuring process. It has been estimated that 60,000 to80,000 workers lost their jobs during 2003. After several ad hoc social programs,the Serbian Government adopted in early 2002 a general social program for laidoff workers. Under that program, a worker who has lost his/her job will receivearound EUR 100 for every year of service. Workers who decide to start their ownbusinesses will receive an additional EUR 500. Workers who start businesses thatemploy at least 10 people will receive additional assistance up to EUR 2,500.Resources for financing social programs for laid off workers are secured for themost part in Serbia’s budget, and a smaller part is provided from local budgetsand foreign grants.

Structural reform

Together with the implementation of the stabilization program, activitieshave been initiated for carrying out wide-ranging structural reform of theSerbian economy. The focus of the activities in 2001 was on the creation of thelegal framework and establishment of institutions which will implement struc-tural reform. The creation of a proper institutional framework enabled signifi-cant progress in the filed of restructuring and privatization in 2002 and 2003.

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The most important progress over the previous period was made in the fol-lowing areas:

• privatization and enterprise restructuring,• restructuring of the banking sector, and• liberalization of the labor market.Through the adoption of the Privatization Law, supporting laws and imple-

menting regulations, as well as through the establishment of adequate institu-tions for the implementation, control and supervision of privatization, in late2001 the institutional framework for enterprise privatization in Serbia wasrounded off. In the course of 2002 and 2003, on the basis of the experiencegained in practice, a series of corrections in the regulations was made with a viewto increasing the efficiency of privatization.

Serbian cash privatization receipts have reached US$1.15 billion, accountingfor 80 percent of contractual obligations totaling US$1.45 billion. About 1200companies were privatized – mostly SMEs privatized by auction. Continuationat this pace implies that the bulk of SMEs slated for privatization through auc-tion will be privatized by mid-2004. Subsequently, SMEs would be privatizedprimarily through bankruptcy. As for large, socially-owned companies, due totheir accumulated structural problems and a lower level of interest from poten-tial buyers, it is probable that their privatization will remain slow.

The structure of the banking sector in Serbia has considerably changed sinceearly 2001: bankruptcy has been initiated for many insolvent domestic banks, anda number of reputable European banks entered the Serbian market. Banking reg-ulations and supervision of commercial banks have been harmonized with Baslestandards and EU practice. The stabilization of the economy and bank restructur-ing have enabled a sizeable increase in savings deposits, facilitating the expansionof bank credit to the non-public sector. The maturity structure of loan repaymentperiods is lengthening: While in early 2001 banks approved solely short-termloans with repayment periods of up to six months, in early 2002, most banksoffered medium-term loans to enterprises and households (up to 5 years).

Through the adoption of a new Labor Law in late 2001 significant liberaliza-tion of the labor market was carried out. The Law does not oblige employers toapply specific criteria when employing their staff in terms of advertising vacan-cies, ranking applicants according to criteria prescribed by the state, etc. Underthe Law, wages are set primarily through contracts and collective agreements arenot obligatory. The Law defines only the minimum wage The minimum netwage in late 2003 was CSD 27 per hour (around CSD 4,698 a month), equivalentto about CSD 39 per hour including employee taxes and contributions (CSD6,789 a month or roughly EUR 100).

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6. CRITICAL ISSUES

The 2002 GDP estimate, measured by the current exchange rate, was aboutUS$ 1,880 per capita, like Macedonia, Romania, Bulgaria.

Figure 5GDP in 2002

The estimate is that in 2003 GDP reached about US$ 2,500 per capita due toreal currency appreciation against the dollar and modest GDP growth.According to available statistics regarding levels of development for 2003, Serbiais somewhat above Romania, Bulgaria and Macedonia, while almost 50 percentbelow Croatia and 70 percent below Hungary.

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Table 14GDP in 2003

This means that per capita incomes are 20-30 percent of the average in theEU. It is therefore clear from these data that raising per capita income through adynamic growth process on a sustainable basis—is a key priority for Serbia.Serbia & Montenegro has achieved a certain degree of macroeconomic stability.Inflation is fairly low, although higher than in advanced transition countries andEU. Additionally, Serbia & Montenegro is growing at rate that are about twice aslarge as EU growth rate; however, after a two year period of recovery and acceler-ated reforms, 2003 has seen a slowing in the rate of economic growth. Thegrowth rate dropped from 4-5 percent (in 2001-2002) to 3 percent (in 2003).Although inflation was 7.7 percent in 2003, large imbalances continued:

• The fiscal deficit amounted to 4.2 percent of GDP on a cash basis.• The current account deficit was 12.5 percent of GDP; much of the cur-

rent account deficit in 2003 have been financed by FDI and foreigngrants.4And the official gross reserves of the NBS rose to $3.6 billion(equivalent to 4.5 months of projected 2004 imports) at year-end.

Selected economic and financial indicators are presented in the next Table.Eko

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Countries Per capita GDP in US$

Albania 1,943 Bosnia & Herzegovina 1,822 Bulgaria 2,103 Croatia 5,084 Kosovo (SM) 869 Macedonia 2,103 Serbia & Montenegro 2,488 Memorandum item Hungary 8,479

4 FDI was on the order of 5.8 percent of GDP, reflecting mostly privatization receipts of 4 percent ofGDP.

Table 15Federal Republic of Yugoslavia: Selected Economic and Financial Indicators,

1996-2003

7. CHALLENGES IN 2004

Combination of current account and fiscal deficit calls for policies to:• Contain the growth in consumption by reducing the fiscal deficit and

controlling the public sector wage bill;• Enhancing cost competitiveness and profitability in the traded goods sec-

tor; and• Accelerating enterprise restructuring and privatization.

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1996 1997 1998 1999 2000 2001 2002 2003 Real economy GDP, in billions of DIN 75.0 106.0 146.0 193.0 358.0 771.8 1,006.9 1,192.8 GDP, in millions of US dollars 14,455.0 16,556.0 13,889.0 10,214.0 8,071.0 11,576.0 15,662.0 20,729.0 Average net real wage, 1997=100 82.0 100.0 102.0 88.0 103.0 115.0 142.0 160.0 Average net real wage in euro 80.0 106.0 86.0 56.0 51.0 102.0 149.0 174.0 (Percent change) Real GDP 9.0 2.5 -18.0 5.0 5.5 4.0 3.0 Gross industrial production 12.1 11.8 4.4 -24.4 11.1 0.0 1.7 -2.7 Retail prices (period average) 94.3 21.3 29.5 42.1 69.9 91.1 21.2 11.3 Retail prices (end of period, 12-month) 39.0 14.2 7.8 (Percent of GDP) General government finances Revenues 39.2 38.9 42.8 43.1 Expenditures 40.1 40.3 47.3 47.4 Cash balance -0.9 -1.4 -4.5 -4.3 Foreign grants 0.7 1.1 0.3 Foreign loans (net) 0.0 1.8 1.1 Of which: Foreign financed projects 0.0 0.8 0.5 Privatization receipts 0.0 2.2 4.5 Domestic financing (net) 0.7 -0.5 -1.6 Commitment balance -3 -1.4 -4.5 -4.3 (12-month percent change) Money supply (end-of-period) M1 47.3 85.1 114.4 80.3 13.3 M2 67.6 61.4 79.1 76.8 23.9 (in billions of US dollars) Balance of payment Merchandise exports 2.0 2.4 3.0 1.7 1.9 2.0 2.4 2.9 Merchandise imports -4.1 -4.8 -4.8 -3.3 -3.7 -4.8 -6.3 -8.0 Trade balance -2.1 -2.4 -1.8 -1.6 -1.8 -2.8 -3.9 -5.1 Current account balance, after grants -0.6 -1.6 -0.7 -0.8 -0.3 -0.5 -1.4 -2.1 (in percent of GDP) -4.1 -9.4 -4.8 -7.5 -4.2 -4.6 -8.8 -10.2 Current account balance, before grants -0.6 -1.6 -0.7 -0.8 -0.6 -1.1 -2.0 -2.6 (in percent of GDP) -4.1 -9.4 -4.8 -7.5 -7.6 -9.7 -12.8 -12.6 Foreign debt (year-end) 9.8 10.5 10.7 11.4 11.9 9.6 14.3 Gross official reserves 0.3 0.3 0.5 1.2 2.3 3.6 (in months of imports of goods and services) 1.1 0.9 1.2 2.4 3.2 4.4

Having in mind two potential causes of macroeconomic instability: the gov-ernment deficit and the external account deficit, discussions between the IMFand country authorities focus on the need to tighten fiscal policy to reduce thepace of domestic demand and improve the current account deficit in the shortrun. But over the long run, the external current account deficit can be reducedmore effectively by strengthening the growth and export capacity of the econo-my. FDI are particularly important in this respect because FDI will both supportinvestment and growth, thus contributing to the reduction in the external imbal-ance over the long run; and it will at the same time provide foreign exchange tofinance the external deficit in the short run.

Fiscal Policy

Fiscal Policy in 2004 should include:• The third stage of tax reform (this will include the introduction of a

value-added tax, the elimination of the financial transactions and shareholdings taxes, harmonization of the base for the social security contri-butions and the personal income tax, further changes to excises, and theelimination of certain nuisance taxes);

• Significant reduction of public expenditure as well as changes to its struc-ture in favor non-wage current and capital expenditure;

• Significant reduction of the fiscal deficit (from 4.2 percent in 2003 to 3.4percent of GDP).

Monetary Policy

The central objective of monetary policy in 2004 is to maintain price stabili-ty. The objectives of monetary policy will be achieved through tight control ofthe NBS’s net domestic assets, which depend crucially on the size of the fiscaldeficit, the structure of its financing, and developments in NBS’s net foreignassets. To achieve monetary policy objectives in the coming year, the NBS willrely primarily on indirect instruments of monetary regulation, such as openmarket operations and interest rate policy. To that effect, the beginning of repooperations is planned for the first half of 2004. By securitizing government debtto the NBS, a sufficient quantity of high quality securities would be generated toinitiate repo operations. Exchange rate developments will continue to serve thepurpose of maintaining price stability while taking into account the need for themedium-term sustainability of the country’s external position. The secondobjective is to prevent sizeable and unpredictable changes in the exchange rate.

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The foreign exchange reserves of the NBS and their relation to the monetaryaggregates provide comfort that the NBS could prevent a sudden change in theexchange rate.

Growth Oriented Policy

Unlike other transition countries, in the first two years of transition Serbiahad high GDP growth rates. The absence of a transition-induced recession is aconsequence of several once-off factors, such as the removal of barriers to for-eign trade and financial transactions, remonetization of the economy (and a risein credit activity on that basis), as well as a substantial inflow of foreign grants. Aslowdown in economic activity in the course of 2003 points to the fact that thepossibilities for economic growth, based on the model in place for the past twoyears, may have been exhausted. Attainment of the relatively high economicgrowth rates envisaged in the coming years (4 to 5 percent) will depend directlyon the degree to which favorable conditions will be created for domestic and for-eign investment.

The most important economic conditions are: low inflation, reduction in theshare of public spending in GDP and a change in its composition, acceleration ofthe restructuring of large socially owned and public enterprises, and develop-ment of the financial sector.

An important indicator and result of good policies would be an increase inthe share of investment in GDP from the present rate of 14-15 percent to over 20percent in the forthcoming years. Unfortunately, Serbia and Montenegro are stillfar from reaching this result.

There is a no doubt that the Yugoslav authorities have done a lot so far.However, according to the status of the Prior Actions, Structural PerformanceCriteria, and Structural Benchmarks, it has to be done ever more. Problems haveto be solved, not postponed.

Successful countries have created institutional arrangements that have com-pensated the losers and allowed growth to proceed. Stagnant countries tend tohave institutional arrangements that favor the status quo. Officials have tochoose , but it is a difficult choise.

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REFERENCES

Reza Baqir, Rodney Ramcharan andRatna Sahay, 2003, “TheConsistency of IMF Programs”,Macroeconomic challenges in lowincome countries, research work-shop, October 23-24.

Bagci, P., and W. Perraudin, 1997,“Do IMF Programs Work?,”Global Economic InstitutionsWorking Paper.

Barro, Robert J., and Jong-Wha Lee,2002, “IMF Programs: Who isChosen and What Are the Effects?”NBER Working Paper No. 8951,pp. 1–37.

Dani Rodrik, 2003, “GrowthStrategies”NBER Working Paper10050.

Federal Republic of Yugoslavia:Membership and Request forEmergency Post-conflictAssistance, Staff Report, IMF,January 2001.

Federal Republic of Yugoslavia:Request for a Stand-ByArrangement, IMF CountryReport, June 2001.

Federal Republic of Yugoslavia: FirstReview Under the Stand-ByArrangement and Request forWaiver of Performance Criterion,IMF Country Report, September2001.

Federal Republic of Yugoslavia:Second Review Under the Stand-By Arrangement and Modificationof Performance Criteria, IMFCountry Report, January 2002

Federal Republic of Yugoslavia: StaffReport for the 2002 Article IVConsultation, Third Review Underthe Stand-By Arrangement andRequest for an ExtendedArrangement, IMF, April 2002

Federal Republic of Yugoslavia:Selected Issues and StatisticalAppendix, IMF, April 2002.

Serbia and Montenegro: First Reviewunder the Extended Arrangement,IMF Country Report, June 2003.

Serbia and Montenegro: SecondReview under the ExtendedArrangement and Requests for

Waiver and Modification ofPerformance Criteria, and forExtension of RepurchaseExpectations, IMF CountryReport, September 2003.

Report on Access to Fund ResourcesDuring 2003, IMF, February 2004.

EBRD, Transition Report 2003Transparency International, 2003

Corruption Perception IndexIMF’s Articles of Agreement

APPENDIX I

Federal Republic of Yugoslavia: Stand-By Arrangement (first review), May 2001-March 2002


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I Prior Actions and Preconditions for Board Consideration.

1. (Federation) Transfer of the Operational and Financial Unit, which is in charge of the accounting and payment orders for defense budget, from the General staff Headquarters to the Ministry of Defense

… Implemented at end-August

II Structural Performance Criteria 1. (Serbia) Increase in average electricity tariff (weighted by consumption) by 40 at least percent.

October 1, 2001 No longer in effect

2. (Serbia) Increase in average electricity tariff (weighted by consumption) by 15 percent.

… October 1, 2001

III Structural Benchmarks A. Fiscal Sector 1. (Serbia) Redesign of the co-payment system in the health care sector, with a view to generating additional revenue of YUD 0.8-1.0 billion on an annual basis.

end-May 2001 Implemented

2. (Montenegro) Adoption of an organic budget system law to standardize budget classification and implementation of a centralized treasury system.

end-June 2001 Implemented on August 8, 2001

3. (Serbia) Issuance of decree revising the list of drugs offered to the general public population in state pharmacies, to bring expenditures on drugs in line with financial resources available to the health care system.

end-June 2001 end-September 2001


end-September 2001 end-September 2001


end-September 2001 end-December 2001


end-December 2001 end-December 2001



8. (Serbia) Set up of Large Taxpayer office in Belgrade end-December 2001 end-December 2001 B. Financial Sector 1. (Federation and NBY) Adoption of a strategy for bank restructuring, in consultation with the Fund and the World Bank.

May 15, 2001 implemented

2. (Federation and NBY) Intervention of the six largest, illiquid, banks in Serbia.

end-June 2001 implemented

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3. (Federation and NBY) The NBY will (a) refine, in close coordination with the BRA and in consultation with Fund and World Bank staff, its pricing matrix to be used to estimate the total costs and fiscal needs for banking restructuring, and (b) recommend either liquidation or possible rehabilitation (through the BRA) of the remaining 7 (of the 11) banks that were found to be category C banks.

September 15, 2001

4. (Federation) Approval by Parliament of the amendments to Law on the Financial Rehabilitation, Bankruptcy and Liquidation of Banks, allowing BRA to act as a bankruptcy liquidator.

end-September, 2001

5. (Montenegro) The CBM will decide on the resolution (liquidation, rehabilitation, mergers, no action) of all banks.

end-September, 2001

6. (Federation) The BRA will develop rehabilitation/resolution plans for the 4 large banks under its control. The plans will include (a) monthly cash flows and operational losses during the rehabilitation period with a view to assessing progress toward achieving core profitability; (b) future business strategies; (c) the fiscal costs of restructuring, which will critically depend on progress in securing creditor haircuts, and (d) a recommendation on whether the bank should be rehabilitated or closed.

October 15, 2001

7. (Federation) The Board of Directors of the BRA, will decide, under Articles 7 and 22 (a) of the Act governing its operations, whether the banks should be subjected to a rehabilitation plan or liquidated. Bank rehabilitation will be undertaken only if it is expected to produce a viable bank with good prospects for privatization; and can be implemented with identifiable fiscal resources. If this does not appear to be achievable based on performance during the first six months of a rehabilitation program, the banks will be closed and liquidated.

end-October, 2001

C. Private Sector 1. (Serbia) Parliamentary approval of privatization legislation in Serbia, designed in cooperation with the World Bank to: (a) attract investment capital by offering at least 70 percent of enterprise shares to investors and no privilege to company management, workers, or any other agents regarding purchase of these shares; (b) create, through dominant ownership, a clear ownership structure conductive to efficient resource allocation and good enterprise management; © facilitate failed enterprise liquidation/work-outs prior to privatization, among other things by authorizing the Privatization Agency to require an enterprise to enter workout/liquidation; (d) establish transparent and efficient privatization procedures; Legislation to include Law on Privatization, Law on Shares, Law on Agency of Privatization, Ordinance on Privatization Program, Ordinance on Public Tender, Ordinance on Auctions, ordinance on Business Valuation, and Ordinance on Appraisers..

end-June 2001 implemented

Source: Federal Republic of Yugoslavia: First Review Under the Stand-By Arrangementand Request for Waiver of Performance Criterion, IMF Country Report, September 2001.

Federal Republic of Yugoslavia: Stand-By Arrangement (second review), May 2001-March 2002


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2. (Serbia) Conclusion of at least six contracts for the privatization of either large companies or pools of six companies each with investment banks hired through competitive international tenders (out of a total of four large companies and five pools).

end-October 2001 end-October 2001




I Prior Actions and Preconditions for Board Consideration.

1. (Federation) Submission to Federal, Serbian and Montenegrin parliaments of proposed budgets for 2002, consistent with key policy parameters in MEFP of December 26, 2001.

… Implemented

II Structural Performance Criteria 1. (Serbia) Increase in average electricity tariff (weighted by consumption) by 15 percent.

October 1, 2001 Implemented

III Structural Benchmarks A. Fiscal Sector 1. (Serbia) Issuance of decree revising the list of drugs offered to the general public population in state pharmacies, to bring expenditures on drugs in line with financial resources available to the health care system.

end-September 2001 Implemented in mid-October 2001.


end-September 2001 Implemented

3. (Montenegro) Completion of a report on the external audit of the budget financing by a reputable international accounting firm.

November 15, 2001 Implemented

4. (Serbia) Submission of the Organic Budget Law and Public Procurement Law to parliament.

… End-December 2001





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8. (Serbia) Set up of Large Taxpayer office in Belgrade end-December 2001 … 9. (Serbia) Submission of a new law on tax assessment and collection to parliament.

… mid-February 2002

10. (Federation and Serbia) Adoption of pension reform legislation, providing for an immediate increase in retirement age by 3 years and indexation of pension to the arithmetic average of price and wage increase.


11. (Serbia) Submission of the Tobacco Law, and Lottery Law to parliament.

… end-January 2002

B. Financial Sector 1. (Federation and NBY) The NBY will (a) refine, in close coordination with the BRA and in consultation with Fund and World Bank staff, its pricing matrix to be used to estimate the total costs and fiscal needs for banking restructuring, and (b) recommend either liquidation or possible rehabilitation (through the BRA) of the remaining 7 (of the 11) banks that were found to be category C banks.

September 15, 2001 Implemented

2. (Federation) Approval by Parliament of the amendments to Law on the Financial Rehabilitation, Bankruptcy and Liquidation of Banks, allowing BRA to act as a bankruptcy liquidator.

end-September, 2001 Implemented

3. (Montenegro) The CBM will decide on the resolution (liquidation, rehabilitation, mergers, no action) of all banks.

end-September, 2001 end-December, 2001

4. (Federation) The BRA will develop rehabilitation/resolution plans for the 4 large banks under its control. The plans will include (a) monthly cash flows and operational losses during the rehabilitation period with a view to assessing progress toward achieving core profitability; (b) future business strategies; (c) the fiscal costs of restructuring, which will critically depend on progress in securing creditor haircuts, and (d) a recommendation on whether the bank should be rehabilitated or closed.

October 15, 2001 Implemented

5. (Federation) The Board of Directors of the BRA, will decide, under Articles 7 and 22 (a) of the Act governing its operations, whether the banks should be subjected to a rehabilitation plan or liquidated. Bank rehabilitation will be undertaken only if it is expected to produce a viable bank with good prospects for privatization; and can be implemented with identifiable fiscal resources. If this does not appear to be achievable based on performance during the first six months of a rehabilitation program, the banks will be closed and liquidated.

end-October, 2001 Implemented

6. (Federation) The NBY will take a decision: (i) to address the accounting treatment of unresolved succession issues, (ii) for financial year 2001, to prepare financial statements on the basis of International Accounting Standards (IAS), and (iii) to adopt IAS as its permanent accounting framework, effective with the 2003 financial years.

… end-December 2001

Source: Federal Republic of Yugoslavia: Second Review Under the Stand-ByArrangement and Modification of Performance Criteria, IMF Country Report, January2002.

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7. (Federation) The Internal Audit Department of the NBY, as part of its regular audit cycle, will review the reconciliation of the accounting records and the NFA data submitted to the Fund for program purposes on a monthly basis, effective with the end-December 2001 data. In addition, the NBY will strengthen the functioning of the Internal Audit Department by: (i) defining its role with the development of a charter and ensuring an appropriate degree of independence and objectivity; (ii) continuing to recruit additional staff with skill levels necessary to successfully conduct financial and information system risk-based audits; and (iii) commissioning an independent assessment of the International Audit Department.

… mid-February 2002

C. Private Sector 1. (Serbia) Conclusion of at least four contracts for the privatization of pools of companies (of 3-5 enterprise each) with investment banks hired through competitive international tenders (out of a total of seven pools for which international advisors will be solicited this year).

end-October 2001 end-December 2001


end-December 2001 end-February 2002

3. Appoint advisors for the privatization of 2 pools comprising a total of 12 companies

… January 15, 2002

4. (Serbia) Offer at least one pools of companies consisting of 3-5 enterprises for sale observing well defined, internationally accepted tender rules.

… end-February 2002

5. (Serbia) Offer at least two pools of companies consisting of 3-5 enterprises for sale observing well defined, internationally accepted tender rules.

… end-March 2002

6. (Federation and Serbia) Request for the opinion of the Supreme Court on a draft memorandum of understanding between the Privatization Agency and Bank Restructuring Agency.

… end-December 2001

7. (Serbia) Adoption of a new labor law to liberalize the labor market.

… end-February 2002

APPENDIX II

Federal Republic of Yugoslavia: Extended Arrangement, March 2002-March 2005Prior Actions, Structural Performance Criteria, and Structural Benchmarks,

January December 2003(first review)

Source: Serbia and Montenegro: First Review under the Extended Arrangement, IMFCountry Report, June 2003.

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Implementation Date I Prior Actions and Preconditions for Board Consideration. 1. Serbia, Montenegro: Parliamentary approval of Serbian and Montenegrin budgets (including provisions for Union-level expenditures) for 2003, consistent with policy understandings in MEFP of April 1, 2003.

II Structural Performance Criteria 1. Serbia: Effective July 1, 2003, increase electricity price by at least 20 percent end-June 2003 III Structural Benchmarks A. Fiscal Sector 1. Montenegro:. Adopt a pension law that shifts the indexation of pensions to a weighted average changes in wages and prices (with the weight of wages not to exceed 50 percent) and raises the minimum retirement age by 5 years in a phased manner.

end-April 2003

2. Serbia, Montenegro: Reach agreement on timetable for harmonizing at the latest by end-2005 trade, customs, and indirect tax regimes.

end-April 2003

3. Montenegro: Begin reporting quarterly budgetary arrears data. end-May 2003 4. Serbia: Bring all line ministries and other direct budget users under the treasury single account.

end-June 2003

5. Serbia: Establish Large Taxpayers Units (LTUs) for Nis, Novi Sad and Kragujevac.

end-September 2003

6. Serbia: Establish and implement a centralized payroll system under the Central Accounting Division of the Treasury.

end-December 2003

B. Financial Sector 1. Serbia: Adopt new National Bank of Serbia law to provide for a National Bank Supervisory Board.

end-December 2003

2. Serbia: Offer majority or controlling stakes to strategic investors in at least 3 of the banks affected by the July 2002 laws on Paris and London Club debt and frozen foreign currency deposits.

end-December 2003

C. Foreign Trade 1. Montenegro: Eliminate all export quotas end-April 2003 D. Enterprise restructuring and privatization 1. Serbia: Government to approve restructuring strategies for the 7 large state enterprises consistent with a significant improvement in their profitability through streamlining of operations and cost-cutting.

end-April 2003

Federal Republic of Yugoslavia: Extended Arrangement, March 2002-March 2005Prior Actions, Structural Performance Criteria, and Structural Benchmarks,

January December 2003(second review)

Source: Serbia and Montenegro: Second Review under the Extended Arrangement andRequests for Waiver and Modification of Performance Criteria, and for Extension ofRepurchase Expectations, IMF Country Report, September 2003.

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Target Date Implementation I Structural Performance Criteria 1. Serbia: Effective July 1, 2003, increase electricity price by at least 20 percent

end-June 2003 Waiver granted on the basis of revised policy understandings (15 percent increase on July 1 and measures to restructure the electricity company.

II Structural Benchmarks A. Fiscal Sector 1. Montenegro:. Adopt a pension law that shifts the indexation of pensions to a weighted average changes in wages and prices (with the weight of wages not to exceed 50 percent) and raises the minimum retirement age by 5 years in a phased manner.

end-July 2003 Met with delay

2. Serbia, Montenegro: Reach agreement on timetable for harmonizing at the latest by end-2005 trade, customs, and indirect tax regimes.

end-July 2003 Met

3.Serbia: Reach agreement between the Ministry of Finance and the NBS outlining mutual responsibilities in government debt and cash management and establishing a committee to coordinate NBS’ monetary operations and MOF’s cash and treasury bill management

end-June 2003 Met

4. Serbia: Bring all line ministries and other direct budget users under the treasury single account.

end-June 2003 Met

5. Serbia: Establish Large Taxpayers Units (LTUs) for Nis, Novi Sad and Kragujevac.

end-September 2003

Met

6. Serbia: Establish and implement a centralized payroll system under the Central Accounting Division of the Treasury.

end-December 2003

Not met owing to change of government in December.

B. Financial Sector 1. Serbia: Adopt Secured Transactions Law end-September

2003 Met

2. Serbia: Adopt Resolution Plan for the largest bank in consultation with the Fund staff

end-September 2003

Not met owing to lack of political consensus, but significant progress was made in preparing the Resolution Plan.

3. Serbia: Adopt new National Bank of Serbia law to provide for a National Bank Supervisory Board.

end-December 2003

Met

4. Serbia: Offer majority or controlling stakes to strategic investors in at least 3 of the banks affected by the July 2002 laws on Paris and London Club debt and frozen foreign currency deposits.

end-December 2003

Not met owing to political constraints; but significant progress was made through early 2004.

C. Foreign Trade 1. Montenegro: Eliminate all export quotas To be implement

in the context of trade

harmonization

Met

D. Enterprise restructuring and privatization 1. Serbia: Government to approve restructuring strategies for the 7 large state enterprises consistent with a significant improvement in their profitability through streamlining of operations and cost-cutting.

end-July 2003 Met

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