COMMISSION OF THE EUROPEAN COMMUNITIES 
COM(94) 229 final 
Brussels, 07.06.1994 
REPORT FROM THE COMMISSION TO THE COUNCIL AND THE 
EUROPEAN PARLIAMENT 
on the implementation of macro-financial assistance to third countries 
a 
REPORT ON THE IMPLEMENTATION OF MACRO-FINANCIAL 
ASSISTANCE TO THIRD COUNTRIES 
I. OVERVIEW 1 
1. Introduction.... 1 
2. Implementation of the assistance packages for 1991 in favour of 
CEEC 2 
3. Other macro-financial assistance packages in 1991 2 
4. Community macro-financial assistance in 1992-93 3 
5. Conclusions 5 
II. HUNGARY.... 20 
1. Introduction • 20 
. 2. Recent Macroeconomic Developments 21 
3. Review of the structural reform programme 23 
4. Assessment and prospects 25 
IIL THE CZECH REPUBLIC AND THE SLOVAK REPUBLIC 26 
1. Introduction. 26 
2. Economic developments in the CSFRin 1992 26 
3. Division of the 1991 EC Loan 28 
4. Economic implications of the dissolution of the CSFR 29 
5. Economic developments in 1993 30 
6. Assessment and prospects 33 
IV. BULGARIA 35 
1. Introduction 35 
2. Macro-economic developments and policies in 1992-1993 35 
3. The structural reform process in 1992-1993 38 
4. Community macro-financial assistance in 1992-1993 and prospects 39 
V. ROMANIA 40 
1. Introduction 40 
t, 
2. Macro-economic performance in 1992 40 
3. Structural reform in 1992.... 41 
4. Review of performance criteria attached to the EC financial 
assistance 41 
5. Developments in 1993 and prospects 43 
VI. ALBANIA 44 
1. Introduction 44 
2. Macro-economic performance in 1992-1993 44 
3. Structural reform 45 
4. Review of performance criteria attached to the EC financial 
assistance 47 
5. Assessment and prospects 48 
VII. THE BALTIC STATES 49 
1. Introduction 49 
2. Estonia 50 
3. Latvia 55 
4. Lithuania........ 59 
VIII. ALGERIA 64 
1. Introduction,. 64 
2. Economic developments in 1992-1993 .65 
3. Status of the reform process 66 
4. A review of macro-ecocomic performance and structural reform 
criteria 68 
5. Assessment and prospects 69 
IX. ISRAEL 70 
1. Introduction 70 
2. Recent economic developments 70 
3. Status of the reform process .73 
4. Assessment ....74 
I. OVERVIEW 
1. Introduction 
Initially conceived for intra-Community balance of payments support, macro-financial 
assistance from the Community has been extended since 1990 to third countries, mainly 
those of Central and Eastern Europe, with a view to supporting their political and economic 
reform efforts. 
The first Community macro-financial operation in favour of a third country goes back to 
February 1990, where the Council, on a proposal by the Commission, decided to grant 
Hungary a five-year ECU 870 million loan in support of the country's efforts to overcome 
structural adjustment difficulties. 
In 1991, in view of the political impetus given by the European Council at its December 
1990 meeting, the Commission presented to the Council a series of Community initiatives 
in favour of Central and Eastern European countries (CEECs) similar to the one decided 
for Hungary. The Council adopted four decisions in that respect granting 6 or 7 year 
financial assistance of ECU 375 million to Czechoslovakia, ECU 290 million to Bulgaria, 
ECU 375 million to Romania and a further ECU 180 million to Hungary' 
All these initiatives were taken in the context of overall G-24 coordinated financing 
packages. Overall the requests totalled some ECU 2.4 billion in 1991, around 50% of 
which was committed by the Community. 
The macro-financial assistance operations have been responding to the following 
principles; that were recently reconfirmed by the Council : 
Exceptional character : the assistance is exceptional in nature. All operations are 
undertaken on a strictly case by case basis. The operations are to be discontinued when 
the recipient country can fully rely on financing from the IFIs and private sources of 
capital. 
Political pre-conditions : the assistance is provided to third countries with which the 
Community maintains close political and economic links, taking into account their 
gegographical proximity, on the proviso that they fully respect effective democratic 
mechanisms. 
Complementarity : the basic prerequisite for the mobilization of the assistance is the 
existence of a significant residual external financial gap, over and above the resources 
provided by the IMF and other multilateral institutions and despite the implementation 
of strong economic stabilization and reform programmes. 
Conditionality: the loans are generally released in successive tranches, the disbursement 
of each of them being conditional upon the fulfillment of macroeconomic performance 
and structural adjustment criteria, normally based on the economic programmes of the 
beneficiary countries, as agreed in an arrangement with the IMF. 
Community macro-financial assistance complements and supports other Community 
assistance instruments, including in particular technical assistance in favour of CEECs 
(PHARE), project financing (EIB), and EC agreements with CEECs (trade and cooperation 
agreements and Europe agreements). In fact, the possibility for the Community to provide, 
in exceptional circumstances, macro-financial assistance is referred to under the chapter of 
financial cooperation in the context of the Europe Agreements recently signed with the 
CEECs. 
2. Implementation of the assistance packages for 1991 in favour of CEEC 
As reported in the Commission's Communication to the Council and the European 
Parliament, dated 16 September 1992', the stabilization and reform programmes supported 
by the Community and G-24 balance of payments assistance presented common features. 
Hungary, Czechoslovakia, Bulgaria and Romania, although starting from different initial 
conditions, all embarked in 1991 upon comprehensive programmes of transformation from 
highly centralized planned systems to market oriented economies, while implementing 
policies to stabilize the financial situation. The attempt to adapt their economic structures 
for integration into the world economy involved far-reaching reforms to move quickly to 
the desired market-based productive structure, including : liberalization of foreign trade; 
price liberalization and a substantial elimination of price subsidies; privatization and 
restructuring of state enterprises; unification of exchange rate and introduction of current 
account convertibility; and financial sector reform. With respect to the exchange rate, both 
Hungary and Czechoslovakia adopted a peg as a nominal anchor; Bulgaria and Romania, 
for lack of foreign exchange reserves, let the exchange rate float. 
The programmes were implemented in the context of an external environment significantly 
harder than initially envisaged, notably with regard to the greater-than-expected decline in 
trade with the ex-CMEA countries, especially the USSR, and in a situation where structural 
reform had not yet generated an adequate supply response. In the circumstances, the 
decline in output turned out to be larger than expected and inflationary pressures persisted 
in most economies. Furthermore, in the case of Bulgaria and Romania, there was a shortfall 
in pledges from non-Community G-24 countries and delays in the disbursement of 
commitments. 
Nevertheless, the countries benefiting from assistance from the Community and the G-24 
determinedly implemented the programme measures, including price and trade 
liberalization, cautious financial and income policies, fiscal and financial reform and 
liberalization of the exchange regime. In addition, the authorities introduced a series of 
important structural measures, with the aim of fostering private economic activity, 
privatizing state assets and building the legal and institutional framework necessary for the 
efficient functioning of a market-based economy. In view of the performance achieved 
with regard to the quantified performance criteria and the structural adjustment criteria, the 
review of the conditionality attached to the Community loans was positively concluded in 
all countries and the assistance from the Community for 1991 was entirely disbursed. 
While all the countries achieved significant results, there have been important differences 
in performance among them, reflecting in part the diversity in the initial conditions that the 
various countries faced at the start of the reform process. Consequently, the advancement 
of the process of return to external viability has varied considerably among the countries. 
In particular, Hungary and Czechoslovakia experienced rapid progress towards access to 
international capital markets, whereas, as anticipated, the mobilization of external private 
funding remained modest in the case of Bulgaria (burdened by an external debt overhang) 
and Romania, which relied heavily on credit from official sources to finance their external 
deficit in the short run. 
Consequently, no additional exceptional financing was required for Hungary and 
Czechoslovakia in 1992, whereas additional macro-financial assistance from the EC and 
the G-24 was needed to sustain the stabilization and reform efforts in Bulgaria and 
Romania. 
3. Other macro-financial assistance packages in 1991 
Two other Community loan operations were decided by the Council in 1991 in favour of 
countries outside the region of Central and Eastern Europe. In the context of Community 
Report on the Implementation of Medium-Term Financial Assistance to the Balances of Payments of Central and 
Eastern European Countries, COM(92)400 final. 
-3-
support for Middle-Eastern and Mediterranean countries adversely affected by the Gulf 
conflict, the Council granted to Israel in July 1991 an ECU 160 million loan, which was 
made available in a single tranche and for a six-year period. The loan, that was 
accompanied by an interest-rate subsidy totaling ECU 27.5 million in charge of the général 
budget of the Community, was released in January 1992. 
In September 1991, another medium-term loan of ECU 400 million was decided in favour 
of Algeria to help the country carry through the political and economic reforms under'way. 
The Community assistance also played a major role in catalyzing an important voluntary 
refinancing arrangement between Algeria and its commercial bank creditors. The first 
tranche of the loan was released in January 1992. However, owing to a later relaxation of 
stabilization and reform efforts, the second tranche could not be disbursed 
4. Community macro-financial assistance in 1992-93 
In late 1992, a second series of Community loan operations was decided by the Council for 
CEECs, comprising : a further ECU 110 million for Bulgaria; a further ECU 80 million in 
a single tranche for Romania; and a global amount of ECU 220 million in favour of" the 
Baltic States (40 million for Estonia, 80 million for Latvia and 100 million for Lithuan-u to 
be disbursed in two tranches). Macro-financial support was also decided in favour for 
Albania (ECU 70 million, also in two tranches) but took the form of a grant in view of the 
low level of development of this country and its lack of creditworthiness. 
All these initiatives were taken in the context of G-24 financing packages designed to 
complement the resources provided by the multilateral financial institutions Overall, the 
requests for exceptional financial assistance from the G-24 totalled US$ 1185 million, of 
which the Community contributed approximately half. 
Clearly, when these new assistance packages were launched the beneficiary countries were 
in different stages of the transition to market economies. Romania and Bulgaria had already 
begun to put in place some of the necessary legislative framework and to implement 
important structural reforms, including -in the key areas of liberalization of foreign trade, 
introduction of convertibility, and price liberalization. Both countries, however, had been 
less successful in macroeconomic stabilization than other CEECs (owing largely to a more 
difficult starting position and a harsher external environment). In Albania and the Baltic 
States reform was still at earlier stages. 
In both Romania and Bulgaria, the new economic programmes were designed to maintain 
the momentum of stabilization and reform. Along with the consolidation of the key 
achievements of 1991 - in particular, the liberalization of prices, trade and the exchange 
rate, and privatization, strict monetary and fiscal policies were essential means to reduce 
inflation and create the necessary preconditions for sustained growth and external viability. 
In Romania, the government maintained prudent fiscal and monetary policies during most 
of 1992. All quantitative macro-economic performance criteria for end-June and end-
September were observed, and the IMF could complete its review of the programme in 
November. Significant progress was made in the implementation of the structural reform 
measures : in particular, consumer prices were substantially further liberalized, and the 
phased elimination of consumer subsidies proceeded on schedule. In view of this progress 
and of the commitment by the authorities to remedy the slippages recorded in the area of 
the exchange rate and the privatization process, the Community loan was disbursed. 
Despite this progress, macroeconomic developments in 1992 showed that the results of the 
economic programme were mixed. Economic activity continued to deteriorate sharply and 
following initial success in bringing down inflation, a surge in prices re-emerged by year-
end that was fed by a relaxation of the monetary stance. Also, the overall balance-of-
payments target for end-1992 was not reached, owing to delays in the disbursement of 
foreign assistance (commitments from the G-24 in particular only reached US$ 111 
million, including ECU 80 million from the EC, against an identified financing gap of US$ 
180 million), and to the inadequate exchange rate policy at the end of the year. As no 
decisive action was taken in 1993 to overcome the persistent difficulties in stabilizing the 
economy, inflation continued unabated, the premium in the parallel market remained 
substantial, and official reserves were depleted by end-1993. Furthermore, the pace of 
reform in state enterprises remained slow. 
Owing to policy shortcomings, Romania was not in a position to make the final purchase 
under the IMF stand-by arrangement before it expired at end-March 1993, and the 
negotiations on a new stand-by arrangement dragged on during most of 1993. 
In Bulgaria, the authorities continued to implement tight macro-economic policies in the 
first half of 1992 that resulted in progress towards stabilization. They also developed the 
legal framework for enterprise restructuring and privatization, and proceeded with the 
reform of the financial sector. 
%However, from mid-1992, in a context of growing political and social tension, the 
authorities relaxed their policy stance. Performance of state enterprises deteriorated. Owing 
to spending overruns, the fiscal deficit widened. Inflation rose again to 5-6% per month by 
the end of 1992 and the arrangement with the IMF went off track. In 1993, policy 
performance remained weak, and efforts by the authorities to maintain the stability of the 
currency through central bank intervention resulted in a sharp drop of official reserves by 
the end of 1993. In the circumstances, negotiations with the IMF on a new arrangement 
could not be concluded and Community assistance remained undisbursed. 
Despite irreversible progress in the process of transformation to a market-based economy in 
both Romania and Bulgaria, delays in the implementation of appropriate reforms have led 
to renewed price pressures. Also, progress towards external viability remained elusive 
through the end of 1993. Clearly, external trade has been depressed by the trade embargo 
on Serbia-Montenegro, and in the case of Bulgaria, by the lack of agreement with its 
commercial creditors on a reduction package for the debt contracted under the previous 
regime. The impact of the external factors has been compounded by inadequate demand 
management and overvalued exchange rates. These policy shortcomings, in turn, have 
precluded the mobilization of foreign official financial assistance. 
The agreement in principle with the IMF in December 1993 on a new programme in both 
countries, and on a comprehensive debt reduction scheme with commercial creditors in the 
case of Bulgaria, should be a major step towards stabilization,, reform and external 
viability. To that effect, further assistance from the EC/G-24 will have to be considered in 
1994 
In Albania, the government embarked on a comprehensive economic reform programme in 
mid-1992, when the country was experiencing severe economic, social and administrative 
dislocation and facing fiscal and external imbalances much larger than in other countries in 
the region at the beginning of their transformation process. The immediate priority of the 
programme was to stabilize the economy and to initiate profound structural changes 
towards an open market economy. 
By mid-1993, the first stage of economic stabilization and reform had been successfully 
achieved. The slide into hyperinflation had been reversed, the downward spiral of output 
halted and financial discipline on state enterprises was enforced. Price reform had advanced 
rapidly, and foreign trade was liberalized. Land privatization had resulted in a significant 
resumption of growth of agricultural production, allowing a rapid phasing-out of the 
massive food aid that the international community, with the EC as a principal donor, had 
been providing since 1991. Macro-financial assistance from the Community (ECU 70 
million disbursed in two tranches in December 1992 and August 1993) and from other G-
24 countries had been instrumental in strengthening the reserve position of the country and 
in allowing the authorities rapidly to stabilize a freely determined exchange rate. The 
stabilization gains remain fragile and tentative, however, and Albania will have to continue 
to rely heavily on foreign assistance in the short run. Exports cover only a fraction of 
import needs, and the external outlook remains clouded by Albania's large external debt. 
The Albanian authorities have now shifted from a mainly short-term horizon, dictated by 
the state of crisis, towards a consistent medium-term approach, by adopting a 
comprehensive medium-term economic programme for 1993-96 that was presented to the 
-5-
G-24 High Level meeting in November 1993. The G-24 recognized the need for further 
macro-financial assistance (complementary to the ESAF arrangement agreed in July 1993). 
In the context of this programmé, Albania will seek an early normalization of relations with 
its commercial creditors. 
It was against a background of major disruptions in the trade, payments, and monetary 
arrangements with the other countries of the former Soviet Union that the Baltic States 
embarked in mid-1992 upon comprehensive programmes of transformation to market-
oriented economies. In the circumstances, the reintroduction of their own currencies at an 
early stage of the adjustment process, in order to insulate their economies from inflationary 
impulses from the other states of the former Soviet Union, constituted an important and 
original feature of the stabilization and economic reform programmes. These programmes 
also encompassed a rapid liberalization of prices and foreign trade to realign domestic 
prices with world prices, as well as strong fiscal and monetary stabilization policies, 
supported by incomes policies designed to adjust real wages to the severe terms of trade 
shocks that resulted from the move by Russia towards world market prices for oil and raw 
material exports. In support of these programmes, substantial financial assistance from the 
international community was mobilized. Assistance by the EC/G-24 reached 87.2 per cent 
of the identified financing gap. 
The Baltic States have been successful in stabilizing their economies despite these severe 
initial conditions; the consistency of the policies pursued by successive governments has 
greatly contributed to this success. In Estonia, furthermore, the currency board 
arrangement, wich provided a strong anchor for the price system, helped gain strong 
confidence from the outset. Despite progress in reforms, restructuring of the banking sector 
has incurred substantial delays. In all three countries, the stabilization process was 
accompanied by large losses in output; however, by end-1993, the output decline had 
bottomed out. The first tranches of EC assistance were disbursed in 1993, and the second 
tranches are expected to be disbursed in early 1994, as reviews are completed. No further 
exceptional macro-financial assistance has been requested by the Baltic States. 
5. Conclusions 
Overall, the Community has committed so far some ECU 3.1 billion in macro-financial 
assistance to third countries (Table 1). This includes in particular the support to CEECs 
that since 1991 has been entirely provided in the context of the G-24 coordination process, 
where an overall amount of US$ 3.5 billion were mobilized, the non-EC donors providing 
roughly 40% of the assistance (Table 2). Among them, Japan has beert, by far, the single 
most important contributor (some 20 percent of overall assistance), followed by the EFTA 
countries (17 per cent altogether). Clearly, the coordinated effort has permitted sizeable 
untied assistance to be mobilized which would probably not have been forthcoming in a 
purely bilateral context. 
This exceptional assistance has been instrumental in the liberalization of foreign trade and 
the introduction of external convertibility in the recipient countries at an early stage of the 
transformation process. More generally, it has improved the mix between adjustment and 
financing and therefore helped stabilize the economy and maintain the momentum of 
reform. This quick-disbursing Community support was also effective in providing the 
implementation in the CEECs of the necessary legal framework and sectoral reforms, 
allowing for a better absorption of project-related Community assistance (PHARE, EIB) 
and private investment from EC member states. Overall, macro-financial assistance by the 
Community (and the G-24) has played a major role in supporting reform and thereby in 
strengthening the democratic process, as it is now clearly recognized. Where governments 
were unable to implement appropriate stabilization and reform policies, however, 
assistance was suspended until policy shortcomings were remedied, and cooperation could 
be re-established. (Macro-economic performance indicators and the status of economic 
reform are summarized in Tables 3 and 4.) 
12) 
-6-
No additional funding from the Community (and the G-24) was required by Hungary and 
the Czech Republic (that regained access to international capital markets) and by the Baltic 
States (that recorded relatively strong external reserve positions). Nevertheless, the 
Community (and the G-24) have to respond this year to further requests from Bulgaria, 
Romania, Albania, and possibly other countries (the Slovak Republic, Algeria, etc.) to 
sustain their stabilization and reform efforts. 
* * 
The present report, submitted in accordance with Council decisions regarding macro-
financial assistance from the Community to Hungary (90/83/EEC and 91/310/EEC), the 
Czech and Slovak Federal Republic (91/106/EEC), Bulgaria (91/311/EEC and 
92/511/EEC), Romania (91/384/EEC and 92/551/EEC), Albania (92/482/EEC), the Baltic 
States (92/542/EEC), Israel (91/408/EEC) and Algeria (91/510/EEC) assesses the 
economic situation and prospects of each country and the progress of economic reforms 
with particular reference to the implementation of the conditions attached to the assistance. 
7-
TABLE 1 
COMMUNITY MACRO-FINANCIAL ASSISTANCE TO THIRD COUNTRIES 
Status of effective disbursements as of 31.01.94 
(in million of ecus) 
Country Maximum amount 
authorized 
(Council Decision) Disbursed Undisbursed 
Hungary I 
(struct, adj 
loan) 
Czech and Slovak 
Federal Republic 
(BOP loan) 
Hungary II 
(BOP loan) 
Bulgaria 
(BOP loan) 
Romania 
(BOP loan) 
Israel 
(struct, adj. 
soft loan) 
Algeria 
(BOP loan) 
Albania 
(BOP grant) 
Bulgaria II 
(BOP loan) 
Baltics 
(BOP loans) 
of which : 
Estonia 
Latvia 
Lithuania 
Romania II 
(BOP loan) 870 
(22.2.90) 
375 
(25.2.91) 
180 
(24.6.91) 
290 
(24.6.91) 
375 
(22.7.91) 
160 
(22.7.91) 
400 
(23.9.91) 
70 
(28.9.92) 
110 
(19.10.92) 
220 
(23.11.92) 
40 
80 
100 
80 
(27.11.92) 610 
(350-April 1990) 
(260-Febr. 1991) 
375 
(185-August 1991) 
(190-Febr. 1992) 
180 
(100-August 1991) 
(80-Jan. 1993) 
290 
(150-Aug. 1991) 
(140-March 1992) 
375 
-(190-Jan. 1992) 
(185-April 1992) 
160 
(March 1992) 
250 
(Jan. 1992) 
70 
(35-Dec. 1992) 
(35-Aug. 1993) 
110 260 
20 (March 1993) 
40 " 
50 (July 1993) 150 
110 
110 
20 
40 
50 
80 
(Feb. 1993) 
Total 3130 2500 630 
Tahle ?-FC/<5-?4 marro-financfal assistance to Central and Eastern Europe since 1991 (cumulative amounts) 
Country 
[Identified 
gaps) 
Community 
EFTA 
United States 
Japan 
Others 
Total ALBANIA 
(USS 165 million) 
Commitments 
Mln 
USS 
825 
124 
20.0 
114.9 %of 
gap 
50.0 
7.5 
121 
69.6 %of 
commit 
71.8 
10.8 
17.4 
100.0 BALTIC STATES 
(US$ 600 million) 
Disburs. I Commitments 
Mln 
uss 
62.5 
4.2 
86.7 Mln 
USS 
300.0 
123.1 
100.0 
523.1 %of 
gap 
50.0 
20.5 
16.7 
87.2 %of 
commit 
57.4 
235 
19.1 
100.0 Disburs. 
Mln 
USS 
150.0 
31.5 
181.6 BULGARIA (1) 
(US$800 million) 
Commitmenbs 
Mln 
USS 
400.0 
95.0 
10.0 
100.0 
8.7 
613.7 %of 
gap 
50.0 
11.9 
1.3 
12.5 
1.1 
76.7 %of 
commit 
65.2 
15.5 
1.6 
16.3 
1.4 
100.0 Disburs. 
Mln 
USS 
400.0 
32.0 
10.0 
442.0 
Country 
[Identified 
gaps) 
Community 
EFTA 
United States 
Japan 
Others 
Total CSFR 
(USS 1000 million) 
Commitments 
Mln 
USS 
500.0 
146.0 
15.0 
200.0 
26.0 
887 %of 
gap 
50.0 
14.6 
1.5 
20.0 
2.6 
,88.7 %of 
commit. 
56.4 
16.5 
1.7 
22,5 
29 
100.0 Disburs. 
Mln 
USS 
500.0 
146.0 
15.0 
200.0 
1.0 
8620 HUNGARY 
(USS 500 million) 
Commitments 
Mln 
USS 
250.0 
95.0 
10.0 
150.0 
12.8 
517.8 %of 
gap 
50.0 
19.0 
2.0 
30.0 
2-6 
103.6 %of 
commit. 
43.3 
18.3 
1.9 
29.0 
25 
100.0 Disburs. 
Mln 
USS 
250.0 
95.0 
10.0 
125.0 
128 
4828 ROMANIA 
(USS 11 BO million) 
Commitments 
Mln 
USS 
590.0 
136.4 
100.0 
220 
848.4 %of 
gap 
50.0 
11.6 
8.5 
1.9 
71.9 %of 
commit 
69.5 
16.1 
11.8 
26 
100.0 Disburs. 
Mln 
USS 
590.0 
136.4 
625 
22.0 
810.9 
Country 
[Identified 
flap*) 
Community 
ERA 
United States 
Japan 
Others 
Total ALL 
(USS 4240 mDDon) 
Commitments 
Mln 
USS 
21225 
607.9 
35.0 
670.0 
69.5 
3504.9 %of 
gap 
50.0 
14.3 
0.8 
15.8 
1.6 
82.8 commit 
60.6 
17.3 
1.0 
19.1 
20 
100.0 Disburs. 
Mln 
USS 
19725 
445.1 
35.0 
387.5 
35.8 
2875.9 
(1 ) Commitments for the 1992/93 exercise are not taken into consideration since the operation has not been implemented. 
Source: European Commissian 
9-
Tablc 3: Selected, economic indicators 
1991 1992 
Programme m Actual Programme n) Actual 1993 
Programme fn Estimates 
GDP at constant prices (Percent change) 
Albania 
Bulgaria 
CSFR 
Czech Republic 
Slovak Republic 
Hungary 
Estonia 
Latvia 
Lithuania 
Romania 
Algeria • 11.0 
-5.0 
-3.0 
0.0 
4.5 -27.0 
-12.0 
-15.9 
-11.9 
-11.8 
-8.3 
•13.4 
-15.1 
02 -220 
-4.0 
-5.0 
2.0 
-28.0 
-25.0 
-25.1 
-5.0 •10.0 
-5.4 
-7.0 
-4.4 
-23.0 
-33.8 
-37.7 
-15.4 
2r8 0.0 
2.0 
-9.0 
0.0 
1.0 11.0 
•4.0 
0.5 
-7.0 
-1.0 
-5.0 
-10.0 
-16.2 
1.0 
Consumer/retail price (end year) (Percent change) 
Albania 
Bulgaria 
CSFR 
Czech. Republic 
Slovak Republic 
Hungary 
Estonia 
Latvia 
Lithuania 
Romania 
Algeria 234.0 
30.0 
31.0 
104.0 
35.0 104.0 
339.0 
52.0 
32.2 
302.7 
262.5 
382.7 
222.8 
22.8 345.0 
44.0 
12.0 
17.0 
1069.0 
130.0 237.0 
79.0 
12.7 
21.6 
953.5 
958.6 
1162.5 
198.5 
32.0 32.0 
15.0 
30.0 
19.2 31.0 
64.0 
18.2 
25.1 
21.1 
35.7 
31.3 
188.6 
298.0 
Fiscal balance - Cash (Percent of GDP) 
Albania 
Bulgaria 
CSFR 
Czech Republic 
Slovak Republic 
Hungary 
Estonia 
Latvia 
Lithuania 
Romania 
Algeria 0.1 
0.8 
-1.5 
-1.5 
4.5 43.7 
-3.7 
-2.0 
-4.4 
4.8 
6.4 
2.8 
-2.6 
4.3 -28.2 
-4.5 
-2.9 
-0.5 
1.0 
-1.8 
0.3 
-2.0 -21.8 
-6.9 
-3.6 
-7.4 
1.0 
0.0 
0.9 
-5.6 
-0.7 •16.7 
-1.0 
-7.0 
-7.0 
0.0 -15.5 
-9.4 
0.0 
-7.0 
-7.0 
0.0 
-0.4 
-0.1 
-2.0 
..7... 
-10 
Table 3 : Selected economic indicators (continued) 
1991 1992 1993 
Programme ro Actual Programme ci) Actual Programma (i) Estimates 
Broad money (Percent change) 
Albania 
Bulgaria 
CSFR 
Czech Republic 
Slovak Republic 
Hungary 
Estonia 
Latvia 
Lithuania 
Romania 
Algeria 5.9 
22.9 
15.0 
11.7 104.0 
122.0 
26.9 
29.4 
153.1 
133.2 
101.2 
21.3 122.0 
38.5 
12.0 
123.0 
270.6 
88.0 153.0 
43.5 
17.5 
27.4 
68.0 
169.9 
351.3 
74.8 
23.6 47.0 
17.5 
19.0 
19.8 51.0 
17.7 
21.0 
76.1 
114.0 
108.0 
Current account (convertible) (in billion USS) 
Albania 
Bulgaria 
CSFR 
Czech Republic 
Slovak Republic 
Hungary 
Estonia 
Latvia 
Lithuania 
Romania 
Algeria -2.00 
-2.50 
-1.20 
-1.70 
-0.31 -0.20 
0.30 
0.33 
0.25 
-1.30 
2.56 -0.50 
-1.40 
-0.60 
-0.65 
-0.18 
-0.09 
-0.16 
-1.30 -0.40 
-0.40 
0.23 
0.26 
-0.01 
0.05 
0.09 
-1.50 
1.20 -0.40 
0.70 
-030 
-1.55 
0.00 
-0.24 
-0.48 -0.40 
-1.00 
0.60 
-2.70 
-0.07 
0.04 
-0.25 
-1.30 
Official foreign exchange reserves (level) (in billion USS) 
Albania 
Bulgaria 
CSFR 
Czech Republic 
Slovak Republic 
Hungary 
Estonia 
Latvia 
Lithuania 
Romania 
Algeria 050 
1.70 
1.90 
1.00 
1.53 0.01 
0.40 
3-20 
4.00 
0.20 
1.61 0.03 
1.00 
2.20 
2.20 
0.14 
0.15 
0.04 
0.70 0.03 
0.90 
1.30 
4.40 
0.20 
0.16 
0.14 
0.10 
1.70 0.07 
2.20 
0.30 
6.00 
0.16 
0_23 
0.15 0.15 
0.70 
3.80 
0.40 
0.34 
0.52 
0.28 
0.05 
(1) Programme targets as set in .'August 92 for Albania, March 91 and April 92 for Bulgaria, 
January 91 for CSFR, March 93 for the Czech Republic, July 93 for the Slovak Republic, 
February 91 and September 93 for Hungary, September 92 for Estonia and Latvia, October 92 for 
Lithuania, April 91 and May 92 for Romania and May 91 for Algeria. 
Sources: National authorities 
-11 
TABLE 4 
STATUS OF ECONOMIC REFORM 
1. ALBANIA 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
7. Privatization and 
enterprise restructuring 
8. Financial sector reform Most wholesale and retail prices freed in 1992-93, with the 
exception of prices for wheat, bread, sugar beet and a number 
of non-food items produced under monopolistic conditions, 
for w-hich major adjustments were mace in mid-1993. 
Major liberalization in 1992-93. No quantitative restrictions 
on imports; import duties ranging 0-40%. Limited export 
restrictions. 
Free float since July 1992. Current account convertibility. 
Large external debt arrears to commercial banks to be 
negotiated. 
Liberal regime, recently streamlined to limit approval 
requirements 
Use of bank-by-bank credit ceilings. Administrative guidance 
to ensure that interest rates remain positive in real terms. 
Ongoing efforts to broaden tax base: personal incomes tax 
introduced in 1993; property tax scheduled for 
implementation in 1994 and VAT in 1995-96. Regarding 
expenditure: major reduction in price subsidies in 1992-93; 
allowance made for investment in line with PIP in budget for 
1994. 
80% of land area privatized with distribution of titles to be 
completed by end 1994. Small privatization in trade and 
services completed. Law on restitution passed in April 1993. 
Industrial enterprises : privatization of small and medium-size 
enterprise in late 1993 through decentralized auction; newly-
created Enterprise Restructuring Agency to supervize 30 
major problem enterprises. However, financial discipline 
reestablished in early 1993 through strict monetary policy and 
abolition of the system of receivable orders. 
Two-tier banking system. Three existing state-owned banks 
still to be restructured, and their non-performing loans 
replaced by government bonds. 
12 
TABLE 4 (Continued) 
2. BULGARIA 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
7. Privatization and 
enterprise restructuring 
8. Financial sector reform Most prices freed in 1991. Close to 90% of retail turnover 
under free prices. Subsidies on some energy prices gradually 
reduced, but prices remain below cost. 
Imports liberalized in 1991. Import tariffs and remaining 
quantitative restrictions on exports low by international 
standards. Trade agreement with the EC and the EFTA. 
Since 1991, unified floating exchange rate and internal 
current account convertibility (with few restrictions). Massive 
Central Bank interventions in late 1993 to limit exchange rate 
depreciation. Large interest arrears on foreign debt. Debt and 
debt service reduction agreement with commercial bank 
creditors expected to be finalized in mid-1994. 
Liberal foreign investment regime allowing direct investment 
(law adopted early 1992). Free repatriation of profits and 
proceeds of liquidation of investment by non-residents. But 
has been limited by delays in reaching DDSR agreement with 
banks. 
Bank-specific credit ceilings remain the main instrument for 
conducting monetary policy, but increasing reliance on 
indirect instruments and reserve money targeting. Limited 
open market operations introduced in 1993. Development of a 
market for government securities. For 1994. specific credit 
ceilings on the largest loss-making enterprises are 
contemplated. 
Laws on VAT, excise tax, tax administration and budget 
procedure adopted in 1993. VAT to enter in force in April 
1994. 
Restitution of land and small urban property to be completed 
in 1994. Most enterprises transformed into joint-stock 
companies, with the State as unique share-holder. Further 
restructuring and privatization of industry on hold in 1992-93, 
allowing therefore hidden privatization and decapitalization of 
the state sector. Bankruptcy legislation still lacking. Financial 
discipline weak. The authorities are contemplating 
acceleration of privatization through a new programme for 
market privatization in 1994 and a voucher-based mass 
privatization scheme for 1995. Private sector accounts for 20-
25% of GDP. 
Two-tier banking system. Banking supervision: prudential 
regulations adopted mid-93; on-site inspections to be held in 
1994. Bank consolidation started in 1991 close to complete. 
Partial clean up operation of commercial banks' balance 
sheets in 1992-93. Law on non-performing pre-1991 loans to 
enterprises (issuance of government bonds against bad debts) 
adopted in December 1993. Stock exchange introduced. 
-1 3 -
TABLE 4 (Continued) 
3. THE CZECH REPUBLIC 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
Public finances 
Privatization and 
enterprise restructuring 
8. Financial sector reform Virtually all prices free, following extensive liberalization in 
1991 and follow up action in subsequent years. Only few 
products still subject to some form of price regulation. 
Imports iberalized, except for a few remaining quantitative 
restrictions on agricultural products, textiles, steel and coal. 
All imports subject to an ad valorem import tariff of about 
6%. Limited number of products still require export licenses. 
Trade agreements with the EC, the EFTA and the Visegrad 
countries. Customs union with Slovakia since dissolution of 
CSFR. 
Current account convertibility almost completed in early 
1991; remaining restrictions to be removed in 1994, with 
phased liberalization of capital outflows. Exchange rate 
pegged to a basket of two currencies (the US dollar and the 
D-Mark). Since February 1993, transactions with the Slovak 
Republic conducted through a clearing system at a different 
exchange rate. 
No limits on equity participation in enterprises by non­
residents, except in the case of a few sensitive or defence-
related sectors. Free repatriation of profits and proceeds from 
the liquidation of investments. 
Czech National Bank (CNB) created in January 1, 1993; 
operates independently from government. Czech crown 
introduced in February 1993. Since October 1992, monetary 
policy conducted through indirect instruments. Banks' 
lending and deposit rates have been gradually freed. 
VAT reformed, excise tax system, and personal income tax 
introduced in January 1993. Profit tax share substantially 
reduced. 
First wave of large-scale privatization completed in Spring 
1993. Second wave to be completed by end-1994. by which 
time about 90% of the assets of the economy will be in 
private hands. Bankruptcy legislation since April 1993 but 
very few companies have filed for bankruptcy. 
Two-tier banking system established in January 1990. Major 
financial institutions partially privatized under first wave of 
large-scale privatization. Since 1991, several measures to 
strengthen banks' balance-sheets. Prague Stock Exchange in 
operation since April 1993. A bond market and a significant 
market for Treasury and CNB bills emerging. 
(3) 
- 14-
TABLE 4 (Continued) 
THE SLOVAK REPUBLIC 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
7. Privatization and 
enterprise restructuring 
8. Financial sector reform 96% of total turnover based on free prices, with regulation 
still in force only in the areas of transportation, heating and 
rental. 
Imports liberalized except for a few sensitive items subject to 
import licences. 6% average tariff. Export licensing remains 
for a limited number of products. Free trade agreements with 
the EC, the EFTA countries and the Visegrad countries. 
Customs union with Czech Republic since dissolution of the 
CSFR. 
Current account convertibility almost completed in early 
1991. Temporary restrictions on current account convertibility 
reintroduced to stem loss of reserves. Exchange rate pegged 
to a basket of 5 Western currencies. Since February 1993, 
transactions with Czech Republic conducted through a 
clearing system at a different exchange rate. 
No limits on equity participation in enterprises by non­
residents, except in the case of a few sensitive or defence-
related sectors. Free repatriation of profits and proceeds from 
the liquidation of investment. 
Slovak National Bank established in January 1993 operates 
independently from government. Slovak crown introduced in 
February 1993. Monetary policy relying on credit ceilings. 
VAT reformed, excise tax system and personal income tax 
introduced in January 1993. Profit tax share substantially 
reduced. 
First wave of large scale privatization completed by Spring 
1993. Second wave, under preparation, will emphasize 
traditional privatization methods (direct sales, tenders, etc.). 
With completion, 80% of state enterprises privatized. A 
bankruptcy law since June 1993 but very few? companies have 
filed for bankruptcy. 
Two-tier banking system established in January 1990. Major 
financial institutions privatized under first wave of large-scale 
privatization. But state-owned Savings Bank with controling 
stake in the biggest commercial bank (VUB). Since 1991, 
several measures to strengthen banks' balance-sheets. 
Bratislava Stock Exchange in operation since 1993 but 
financial markets remain underdeveloped. 
- 15-
TABLE 4 (Continued) 
5. HUNGARY 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
Privatization and 
enterprise restructuring 
8. Financial sector reform Nearly all price controls and subsidies eliminated 
About 93% of non-agricultural imports liberalized. Several 
industrial products subject to import licensing. Imports of 
consumer goods under a universal quota system. Free trade 
agreements with the EC, the EFTA and the Visegrad 
countries. 
Current account convertibility, except for certain services and 
transfers. Crawling-peg svstem against US dollar and D-
Mark. 
No limits on equity- participation in enterprises by non­
residents, except in the case of a few sensitive or defence-
related sectors. Free repatriation of profits and proceeds of 
liquidation of investment by non-residents. 
Monetary policy through indirect instruments. 
Taxation gradually shifting away from corporate taxation 
towards personal income and consumption. VAT introduced 
in 1988. Large cuts in State subsidies from 13% of GDP in 
1988 to less than 5% in 1993. 
About 20% of the business property' held by the state in 1990 
privatized. Private sector accounting for some 45% of GDP 
end 1993. Tough bankruptcy law into effect since January 
1992. 
Two-tier banking system introduced in 1986. Interest rates 
progressively freed. Several operations to recapitalize and 
clean up banks' portfolios. State holds controlling stakes in 
major banks but the Banking Law requires a reduction of state 
ownership in all banks to 25% by 1997. Budapest Stock 
Exchange opened in June 1990. 
16 
TABLE 4 (Continued) 
6. ESTONIA 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
7. Privatization and 
enterprise restructuring 
8. Financial sector reform Major price liberalization in 1991. By end 1992, virtual 
completion of price liberalization, including in energy sector. 
In early 1992, abolition of most import tariffs (except few 
luxury goods), and of most remaining quotas and licensing 
requirements except for oil shale, clay, quartz. Import subject 
to a 0.5% administrative fee plus 18% VAT. Few exports 
tariffs (art works, rape seed oil, metals). Free trade agreement 
with Baltic States and Nordic countries. 
Current account convertibility. In June 1992 departure from 
rouble zone. Since 1992, Estonian Kroon pegged to the D-
Mark under a currency board system. 
Free repatriation of profits and proceeds of liquidation of 
investment by non-residents. 
Central bank responsible for operation of currency board 
(Issue Department) and, in exceptional cases, for emergency-
lending to banking system (Banking Department, responsible 
for managing reserves in excess of currency board cover). 
Bank does not interfere with the setting of interest rates by 
commercial banks. 
In 1991, personal income tax and VAT introduced, turnover 
tax replaced by corporate income tax; social security, natural 
resource and specific excise taxes introduced. 
Well advanced in small-scale privatization (more than 50% 
privatized by mid-1993); slower progress on large-scale 
privatization. Establishment of Estonian Privatization 
Agency in 1992 to organize the privatization process. 
Two-tier banking system. Increased pressure on state 
enterprises to restructure through hard budget constraints and 
selective application of the bankruptcy law. Reduction of 
number of commercial banks from 40 to 24 through increase 
in minimum capital requirement following a banking crisis in 
Winter 92/93. Stock exchange introduced. 
17 
TABLE 4 (Continued) 
7. LATVIA 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
7. Privatization and 
enterprise restructuring 
8. Financial sector reform Major price liberalization in 1991 and 1992 including for 
energy products. Maximum profit margins abolished. By end-
1992, price liberalization essentially completed, excluding 
utility prici s and rents. 
All export quotas and licensing and most export tariffs 
abolished in 1992. No licensing requirements for imports, but 
various import tariffs. Free trade agreements with Baltic 
States and Nordic countries. 
Exchange rate unified and current and capital account 
convertibility introduced. In July 1992 departure from rouble 
zone. Exchange rate of lats stabilized under managed floating 
system 
Free repatriation of profits and proceeds of liquidation of 
investment by non-residents. 
Independent central bank. Credit policy through indirect 
instruments. 
New tax system since January 1991. VAT introduced in 
February 1992. In 1993 replacement of progressive income 
tax by flat rate tax (25%) plus a 10% surcharge on annual 
income. 
Substantial progress on small-scale privatization, but barely 
any progress on large-scale privatization. Problems still to be 
solved : restitution issues and establishment of a centralized 
and coherent privatization strategy. State enterprises not up 
for immediate privatization transformed into stock 
companies. Slow progress on liquidation. 
Two-tier banking system. 49 former branches of the Bank of 
Latvia either merged into a core bank (21 now forming the 
Universal Bank to be restructured and privatized later) or 
privatized, except for one which was liquidated. Capital 
adequacy ratio increased in January 1994. Stock exchange 
introduced. 
-1 
TABLE 4 (Continued) 
8. LITHUANIA 
1. Price liberalization 
Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
Privatization and 
enterprise restructuring 
8. Financial sector reform Major price liberalization in 1991, 1992 and 1993, including 
for most energy products. Level of subsidization reduced for 
natural gas (household use), heating, transport and hot water ; 
plans to abolish subsidization completely in Fall 1994. 
Export quotas and licensing removed partially in the course of 
1992 and completely in June 1993. All import controls and 
licenses removed. New system provides for import tariff rates 
between 5 and 15% on majority of goods. 
Exchange rate unified and current and capital account 
convertibility'. Left rouble zone in Fall 1992. Exchange rate of 
litas stabilized vis-à-vis a basket of Western currencies. 
Free repatriation of profits and proceeds of liquidation of 
investment by non-residents. 
Largely independent central bank. Credit policy through 
indirect instruments. 
Reform of tax system which now includes personal income 
and profit taxes, property tax, natural resource tax, individual 
excise taxes, as well as general sales tax. 
Substantial progress on small and large-scale privatization 
through auction, public share subscription and voucher 
system. By January 1994, 2/3 of all companies eligible for 
privatization (1/3 of state capital) privatized. Little progress 
on land privatization. Autonomous operation of state 
enterprises promotes efficiency. 
Two-tier banking system. Creation of two-tier banking 
system in 1992 with State Commercial Bank taking over all 
commercial functions of Bank of Lithuania. No further 
progress on reforming the banking sector dominated by three 
State Banks is expected in 1994. Stock exchange introduced.. 
19-
TABLE 4 (Continued) 
9. ROMANIA 
1. Price liberalization 
2. Trade liberalization 
3. Exchange regime 
4. Foreign direct investment 
5. Monetary policy 
6. Public finances 
7. Privatization and 
enterprise restructuring 
8. Financial sector reform Liberalisation of most prices completed in May 1993. 
Energy prices remain controled but adjusted regularly 
for changes in international prices. Public utilities and 
some basic staple food prices still controled and 
subsidised. 
Fully liberalised. A limited number of import/export 
quota/bans is still in force, either for health reasons or 
for subsidised goods. Trade agreement with the EC and 
theEFTA. 
Mutiple exchange rate practice. Official exchange rate 
established at Central Bank foreign currency auctions 
which are not market clearing. Foreign exchange 
available to individuals through private exchange 
bureaus at a free market rate, substantially above the 
official rate. Major overhaul of the exchange rate 
regime is expected in early 1994. 
Free legal environment for equity participation and 
profits repatriation by non-residents. Lack of progress 
with respect to privatisation has limited the volume of 
investment inflows. Land ownership by foreign 
nationals not allowed yet. 
Attempts to tighten monetary policy by an increase in 
refinancing rates; but strongly negative real interest rates 
stimulate flight into foreign currency holdings. Weak 
financial discipline of state companies. 
Major reforms including succesful introduction of single 
rate VAT, abolition of nearly all consumer subsidies and 
incorporation of extra-budgetary funds into a 
consolidated budget. New profit tax law. Overhaul of 
the income tax system is expected by end 1994. 
Substantial progress with privatisation of small-scale 
enterprises through management-employee buy-outs. 
Progress with medium- and large scale enterprises 
privatisation through the State Ownership Fund remains 
far below targets. About 80% of arable land has been 
privatised by distribution to farmers. Registration of 
land titles is on-going. Private sector about a quarter of 
GDP mid-1993. 
Two-tier banking system. Several foreign banks already 
operational. Clearing of interbank payments and 
transfers remains very slow. Privatisation of former 
state-owned banks expected to start in 1995 only. 
- 20 -
H. HUNGARY 
1. Introduction 
In the autumn of 1989 Hungary was at a critical turn of its recent economic and political 
history. A comprehensive set of measures to promote structural reform and adopt a market 
economy model were being implemented and the country was preparing to hold the first 
free elections of the post-war period (eventually held in April 1990). On the 
macroeconomic front, however, the situation was extremely difficult. A sharp deterioration 
of the domestic and external economic and financial situation in the first half of 1989 had 
led to the suspension of IMF support in the summer of that year. The emergence of an 
unsustainable current account deficit (which would reach almost US$ 1500 mio for the 
whole of 1989) and a heavy foreign debt burden threatened the consolidation of the 
economic and political reforms. 
In this context, the Hungarian authorities requested supplementary medium-term financial 
assistance to the European Community to help the country meet its growing debt service 
burden, rebuild its foreign exchange reserves and introduce current account convertibility. 
In response, the Council agreed on 22 February 1990 (Decision 90/83/EEC) to grant an 
ECU 870 million medium-term loan to help Hungary overcome the difficulties of the 
structural adjustment of its economy. 
The 1990 loan was to be disbursed in three tranches, the first of which (of ECU 350 
million) being conditional on the conclusion of a stand-by agreement between Hungary and 
the IMF and the other two on the fulfillment of the macroeconomic and structural 
performance criteria listed in the Memorandum of Understanding subsequently signed 
between the Commission and the Hungarian authorities. The first tranche was effectively 
disbursed in April 1990 and, following a successful review by the Commission of progress 
in economic stabilization and reform (including the compliance with the Memorandum's 
performance criteria), the second tranche (of ECU 260 million) was released in February 
1991. 
Changes in the international environment, and in particular the collapse of the Council of 
Mutual Economic Assistance trading and payments system, made it clear at the beginning 
of 1991 that Hungary, like other Central and European countries, would be facing a much 
more difficult external position than was initially forecasted. While the IMF granted in 
1991, at the Hungarian authorities' request, an Extended Financing Facility (EFF) and 
access to the Compensatory and Contingency Facility under the "oil window", the Fund's 
assistance was not expected to be sufficient to cover all the exceptional balance of 
payments financing needs for 1991 Accordingly, Hungary requested complementary 
financial assistance from the Community and the Group of Twenty-Four (G-24). This led 
the Council to adopt on 24 June 1991, on a Commission proposal, a new Decision 
(91/310/EEC) providing further financial assistance to Hungary of ECU 180 million, with 
the understanding that a similar amount would be provided by the other members of the G-
24. The objectives of this new initiative were to ensure a sustainable balance of payments 
situation and to strengthen Hungary's reserve position. 
The 1991 loan was to be disbursed in two installments. The release of the first installment 
(of ECU 100 million), which was conditional upon the Hungarian government reaching 
agreement with the IMF on a three-year EFF, took place in August 1991. The release of the 
second tranche (of ECU 80 million) was agreed in mid-1992, following the Commission's 
review of Hungary's economic situation and the fulfillment of the performance criteria 
listed in the 1991 loan's Memorandum of Understanding but, for technical reasons, the 
assistance was actually disbursed in January 1993. The Commission agreed with the 
Hungarian authorities to consider at a later stage the disbursement of the third tranche of 
the 1990 loan. This tranche, amounting to ECU 260 million, has not been disbursed to date. 
As noted in the previous report, Community macro-financial assistance to Hungary has 
undoubtedly played an important role in helping the country overcome the difficult 
economic and political situation it faced at the beginning of its current process of reforms. 
The delicate balance of payments situation that prevailed in 1989 threatened to increase to 
-21-
unacceptable levels the costs in terms of lost output and unemployment associated with the 
macroeconomic stabilization an structural transformation of the economy. This risked, in 
turn, weakening the support of the Hungarian population for the economic and political 
reforms. EC macro-financial assistance was successful both in easing Hungary's balance of 
payments constraint and in helping the country restore its access to the international private 
capital markets. 
The following sections review economic developments in Hungary in 1992 and 1993. 
2. Recent Macroeconomic Developments 
2.1. Output and unemployment 
The four-year reform programme adopted by the Hungarian government in early 1991 had 
projected a modest 3% decline of GDP in 1991, followed by a 1 to 3% increase in 1992, 
accelerating in 1993. In the event, real GDP fell by 11.9% in 1991, by a further 4.4% in 
1992, and is estimated to have declined by 1% in 1993 despite an encouraging recovery of 
industrial production in the second half of the year. 
The weaker than expected behaviour of total output in 1992 and 1993 is partly explained 
by the collapse of agricultural production. Between December 1991 and December 1993 
agricultural output is estimated to have fallen by about 30% reflecting a severe drought, 
cut-backs in investment and export subsidies and problems and delays in the privatization 
and structural transformation of formerly state-owned farms. 
Industrial production declined a further 9.8% in 1992 but has been experiencing a distinct 
recovery since last summer. Thus, industrial output was in the period January-November 
1993 4.3% higher than in the same period of 1992 and was growing in November 1993 at a 
year-on-year rate of 7%. 
Unemployment growth slowed down in 1991, with the registered unemployment rate 
increasing from 8.5% at end-1991 to 12.3% at end-1992. After reaching a peak in March 
1993, the number of registered unemployment has been steadily declining, standing at 
632.000 by the end of 1993, or 12.1% of the labour force. While this trend partly reflects 
the decreasing number of people receiving unemployment benefit, it may also reflect the 
fact that much of the labour shedding associated with the restructuring and liquidation of 
enterprises has already taken place. 
2.2 Inflation 
In the first half of 1992, substantial progress was made in reducing inflation, partly thanks 
to the "strong-forint" policy pursued by the authorities. Year-on-year inflation fell to 20% 
in July 1992 from 32.2% at end-1991. However, in the second half of 1992 monthly 
inflation accelerated again, reflecting a large drought-related surge in seasonal food prices 
and anticipatory buying in advance of the January of 1993 VAT reform. In 1993, increases 
in the VAT and excise taxes aimed at controlling the budget deficit, combined again with 
above-average price increases, have caused inflation pressures to remain high. Thus, at the 
end of December 1993, year-on-year inflation stood at 21.1%, about the same level as in 
December 1992 (21.6%). Consistent with the real appreciation of the forint, however, 
producer prices are increasing half as fast as consumer prices. 
2.3. Fiscal policy 
In 1992, the deficit of the consolidated state budget widened sharply (from 4.4% of GDP in 
1991 to 7.4% of GDP), leading in mid-1992 to the interruption of the EFF agreed with the 
IMF in 1991. Despite the corrective measures taken last summer, which included, as 
indicated before, an increase in indirect taxes, the deficit is estimated to have reached 7% 
of GDP in 1993. Such measures were part of the conditions agreed with the IMF to obtain 
last September a 15-month stand-by credit. The authorities' commitments with the IMF 
also include other corrective fiscal measures to be implemented in 1994. However, 
(4) 
-22-
reflecting upward revisions in debt service due to higher than expected interest rates, the 
1994 budget that was approved by the Parliament in December 1993 foresees a 
consolidated budget deficit Ft 81 bn higher than the Ft 249 bn target initially agreed with 
the IMF. 
The difficulties that Hungary has encountered in reining in its budget deficit are basically 
due to the sharper than expected contraction in economic activity (which has both 
weakened revenues and increased unemployment compensation), difficulties to tax the 
emerging private enterprises and incomes, and several one-time events often linked to the 
reform efforts. Among the one-time events, the most important are the loss of revenues 
from taxation of oil imports following the shift of CMEA prices to world market levels, the 
suspension of tax and social security payments by firms filing for bankruptcy proceedings 
as a result of the adoption of the Accounting and Bankruptcy Laws, and the costs 
%associated with the clean-up of banks' balance-sheets (including the sharp fall of profit 
taxes from financial institutions as banks accelerated their provisioning to comply with the 
new capital adequacy requirements). Another factor increasing pressures on the budget has 
been the rapidly rising public debt interest payments due to the larger-than-programmed 
deficits. 
While some of the fiscal problems faced by Hungary will gradually disappear as the 
economy and the tax base recover, other problems will remain. This is obviously the case 
of the erosion of the traditional state-enterprise tax base and the pressures to extend social 
security benefits. 
2.4. Monetary policy 
From late 1991 through mid-1993, the National Bank of Hungary (NBH) allowed banks' 
liquidity to build up so as to put downward pressure on market interest rates, and reduced 
on several occasions its official interest rates. This policy, however, met with only partial 
success as banks, fearful of lending to insolvent companies and needing to increase 
provisions against bad loans in their portfolios, cut lending rates much more slowly than 
deposit rates. As a result, spreads between lending and deposit rates widened substantially 
and, with producer prices rising much more slowly than consumer prices, this led to the 
coexistence of very high real interest rates for loans to enterprises (which hampered private 
investment) and negative real interest rates for depositors (which undermined incentives for 
private saving). In contrast with commercial lending rates, yields on treasury bills were 
pushed down rapidly as banks sought safe investments for their excess liquidity. 
At the beginning of last summer it became clear that interest rates on deposits and 
government paper had been allowed to decline too much. The high public borrowing 
requirements, the weakening of private savings and doubts about the authorities' 
commitment to a "strong forint policy" were beginning to put upward pressure on short-
term interest rates. In that context, the NBH decided to raise its intervention rates last July 
and again last September. 
2.5. Balance of payments and exchange rate policy 
Since the third quarter of 1992, the Hungarian current account has suffered a sharp 
deterioration and is expected to show a deficit of about US$ 2.7 bn (7.5% of GDP) in 1993 
(against a US$ 261 mio surplus in 1992). This rapid worsening of Hungary's current 
account is basically explained by four factors. First, domestic demand is experiencing a 
recovery at a time when Hungary's main Western export markets are suffering from 
recession or very weak growth. Second, agricultural production and exports have collapsed 
as a result of recent droughts and the disorganization caused by the privatization or 
transformation of state-owned farms and cooperatives. Third, exports have also been 
negatively affected by the observance of the UN embargo against Serbia and Montenegro. 
And fourth, Hungary has suffered an important loss of external competitiveness in recent 
years, as reflected in a cumulative appreciation of the forint's real exchange rate or around 
35% (measured with consumer prices) since the beginning of 1990. 
-23-
The real appreciation of the forint is the main cost of the "strong-currency policy" followed 
by the authorities until recently to bring down inflation. Such ?. policy basically meant that 
the forint was regularly devalued within a "crawling-peg system" but in amounts 
insufficient to fully compensate Hungary's inflation differential with its main trading 
partners. The poor performance of exports since the third quarter of 1992 has led the 
authorities to increase since early 1993 the frequency and magnitude of the forint 
devaluations in order to produce some real depreciation of the currency. With inflation 
remaining above 20%, however, the impact of this shift in policy on the real exchange rate 
has so far been very limited. 
While exports are expected to grow substantially in 1994, as agricultural production and, to 
a lesser extent, foreign demand recover, this will be partly offset by the increase in imports 
as domestic demand accelerates. Furthermore, the recovery of exports itself could be 
limited by the weak competitive position of the outward-processing sector, persistent 
structural difficulties in the agricultural sector and the loss of export base associated with 
the bankruptcy of a large number of traditional export companies. In this context, the 
current account deficit is expected to shrink only moderately in 1994 (to about 6% of 
GDP). 
Despite the very high current account deficit, official foreign exchange reserves expanded 
from US$ 4.4 bn at end-1992 to US$ 5.7 bn at the end of October 1993. This was made 
possible by the following two reasons. First, with an estimated US$ 1.3 bn net inflow of 
foreign direct investment (FED) in 1993, Hungary continues to be the main beneficiary of 
FDI flowing into Central and Eastern Europe. Second, Hungary enjoys an easy access to 
the international capital markets, which has allowed the NBH to successfully place 
international bonds in 1993 in the amount of about US$ 4 bn. 
The negative side of the aggressive international borrowing programme of the NBH has 
been a rapid growth of foreign debt in 1993. Total convertible debt, which had decreased 
by US$ 0.9 bn in 1992, is estimated to have risen from US$ 21.5 bn at end-1992 to US$ 
24.9 bn at end-1993. The debt/GDP ratio has also deteriorated slightly, reaching an 
estimated 66.3% at the end of last year. There has been, however, a significant 
improvement in the structure of the debt, with the proportion of medium and-long term 
debt increasing from 89.8 to 92.8%. 
Total debt service amounted to 4.3 bn, practically the same level as in 1992. However, with 
exports estimated to have fallen by about 20% in 1993, the debt service ratio has 
considerably worsened, increasing from 43.9 to 48.1%. Principal repayments are expected 
to amount to around US$ 2.5 bn this year, down from US$ 2.8 bn in 1993, but they are 
projected to rise sharply in 1995 and 1996 to, respectively, US$ 3.4 bn and US$ 3.9 bn. 
With the current account deficit expected to remain at relatively high levels in those years, 
this "bunching" of amortizations could put considerable pressure on Hungary's balance of 
payments. 
3. Review of the structural reform programme 
Important steps have been taken in recent years in all the main areas of structural reform in 
order to transform the Hungarian economy into a market economy. These have basically 
included : 1) tax and other public sector reforms; 2) the removal of most subsidies and 
price controls; 3) the almost complete liberalization of trade and other current international 
transactions; 4) privatization and the strengthening of governance of firms remaining under 
state control; 5) the introduction of new accounting and bankruptcy laws; and 6) a series of 
measures to reform the banking system. Since 1992 efforts have been concentrated in these 
last three areas of reform. Also significant has been the signature of several trade and 
association agreements with the EC, the EFTA countries and Hungary's Central European 
neighbours.Hecent actions in these four fields are described in what follows. 
3.1. Privatization and the strengthening of governance in state enterprises 
Privatization started in Hungary in 1988 with the adoption of the 1988 Company Act and 
the 1988 Foreign Investment Act. Since then, privatization has been carried out through a 
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number of different programmes and vehicles. Changes of approach have been frequent but 
in general privatization has relied heavily on foreign capital and has emphasized sales to 
"real owners", that is, those who would take an active role in managing the privatized 
enterprises. The important role assigned to foreign investors is explained by the initial 
desire to maximize foreign exchange revenues at a time of balance of payments difficulties, 
the limited financial wealth of domestic investors and the need to bring Western 
technology, and marketing and managerial expertise to Hungarian firms As for the 
emphasis on sales to "real owners", it has avoided the negative implications for the proper 
restructuring of the enterprises that may result from the excessive dispersion of ownership 
created by mass-privatization schemes. 
One limitation of the Hungarian approach to privatization (as opposed to, for example, the 
Czech and Slovak "voucher-based" schemes) it that it has resulted in a slow pace of 
privatization for big state-enterprises. Thus, while almost all retail establishments under the 
control of the State Property Agency have now been privatized, the government estimates 
that only about 20% of the total business property held by the state in 1990 has been 
privatized. The growth of the Hungarian private sector in recent years is, thus, explained 
more by the creation of new, previously inexistent firms than by the transfer to private 
hands of state property. The combination of both factors has increased to about 45% the 
share of GDP generated by the Hungarian private sector in 1993 (from 15% in 1990). 
In order to both avoid a possible loss of steam of the privatization process and increase the 
participation of domestic investors, the Hungarian authorities have taken several initiatives. 
These have included compensation for past expropriations with warrants that can be used to 
purchase state property, preferential credit arrangements to facilitate purchase of state 
assets by domestic investors and "leasing" arrangements to enable Hungarian managers to 
buy their companies. Also, the government has introduced a new programme for small 
domestic investors to acquire with deferred payment shares in privatized enterprises. 
Concerning the strategy for residual state ownership, the government announced in August 
1992 a list of 150 business organizations in which the state will retain at least part-
ownership. In October of that year the "State Asset Management Company" (AVRT) was 
created to manage and restructure if necessary those companies, and to sell the specified 
share not to be retained by the state. 
3.2. Accounting and bankruptcy laws 
Following several unsuccessful bankruptcy laws, a drastic bankruptcy legislation came into 
force in January 1992 which forced any company with payments in default for more than 
90 days to file for bankruptcy or liquidation procedures. The result was quite dramatic. 
According to the OECD, in 1992 about one in every six cornpanies applied for bankruptcy 
or liquidation, representing about 17% of employment and 25% of exports. 
To reduce the harshness of the January 1992 law, the Parliament has recently approved 
some amendments, including the substitution of the mandatory self-initiation of bankruptcy 
procedures by the initiation by creditors. The amended law, is hoped, will allow illiquid but 
potentially viable companies to escape lengthy proceedings and will make it more likely 
that creditors will arrive at more constructive solutions. 
3.3. Banking reforms 
In 1986 Hungary became the first country in Central and Eastern Europe to establish a two-
tier banking system separating central bank from commercial bank activities. Since then, 
the permitted operations of commercial and savings banks have been gradually enlarged, 
interest rates have been progressively freed and the National Bank's and Foreign Trade 
Bank's monopoly on foreign exchange operations has been loosened. Furthermore, since 
1986 the state has on several occasions injected capital into the banking system to improve 
the solvency of state-owned institutions and a new Banking Law was passed in December 
1991 subjecting financial institutions to prudential regulations modeled on the Community 
financial Directives and the Basle Committee capital adequacy regulations. Supervision has 
also been strengthened through the establishment of a special supervisory agency in charge 
-25-
of overseeing banks' compliance with prudential regulations and, in case of a capital or 
liquidity shortfall, designing bank restructuring programmes. Finally, a National Deposit 
Insurance Fund was created last July. 
All these steps have not been, however, sufficient to solve the problem of bad loans in the 
banks' portfolios which, like in other Central and East European countries, limits the 
effectiveness of banks' financial intermediation. Efforts to recapitalize banks were 
increased at the end of 1992 with the adoption of a "loan consolidation scheme", whereby 
government bonds were swapped for 50 and 80% of the face value of non-performing loans 
outstanding in, respectively, 1991 and 1992. A new bank consolidation operation was 
launched in December 1993. Such operation, which is to be supported by a US$ 150-200 
mio Financial and Enterprise Sector Adjustment Loan from the World Bank, aims at 
recapitalizing the banks through the acquisition by the state (in return for 20-year 
government bonds) of new shares in 8 major Hungarian banks. In contrast with the 1992 
bank consolidation operation, this new scheme leaves to banks most of the responsibility in 
forcing the reorganization or otherwise liquidation of the debtor enterprises. 
3.4. ' The new regional trade agreements 
The trade protocol of the Association Agreement between Hungary and the Community 
became effective on 1 March, 1992 and the "Visegrad agreements" with Poland, the Czech 
Republic and the Slovak Republic entered into effect on 1 March, 1993. A similar trade 
agreement with the EFTA countries came into effect in October 1993. All these agreements 
aim at a gradual lowering of import barriers with the final objective of establishing a free 
trade zone (except for agriculture) within a maximum period of ten years. While the 
Visegrad agreements are symmetrical, those concluded with the Community and the EFTA 
are asymmetrical, that is, the Community and EFTA countries will reduce trade barriers 
first, with Hungary only reciprocating at a later stage. With the ratification of the 
Association Agreement by EC Member States having been completed, the Agreement came 
fully into force in February 1, 1994. 
4. Assessment and prospects 
Since the presentation of the 1992 Report, progress has continued to be made in the area of 
structural transformation, particularly in the fields of banking reform and bankruptcy 
legislation. On the macroeconomic front, there has been a considerable deterioration as far 
as the fiscal and current account situation is concerned, with the IMF interrupting, as noted, 
the 1991 EFF in mid-1992 due to non-compliance with the fiscal targets. However, the new 
economic policy programme agreed between the Hungarian authorities and the IMF in the 
first half of 1993, and supported by the September 1993 stand-by arrangement, involves a 
serious effort of budget consolidation. Furthermore, the authorities are contributing to 
macroeconomic stabilization through the conduct of a very prudent monetary policy. 
Finally, a strong inflow of FDI and a relatively high degree of access to the international 
capital markets has allowed Hungary to finance without problems its growing current 
account deficit, making it unnecessary for the G-24 to complement the IMF stand-by with 
further macro-financial assistance. 
No doubt Hungary still faces difficult challenges ahead. It will have to take tough 
measures to reduce the public deficit without loosing popular support for the reforms. It 
will also have to bring down its current account deficit and foreign debt burden to less 
uncomfortable levels. Finally, the Hungarian government will have to persevere in its 
structural measures to avoid a loss of momentum in the transformation programme. The 
authorities are taking the right steps in these directions and the country's main political 
forces seem committed to carrying forward the transition process. This, as well as the 
fairly high degree of consensus among the population in favour of the reforms, should 
ensure that progress continues to be made in the years to come. 
-26-
m. THE CZECH REPUBLIC AND THE SLOVAK REPUBLIC 
1. Introduction 
In February 1991 the EC Council (Council Decision 91/106/EEC) granted an ECU 375 
million loan to the former Czech and Slovak Federal Republic (hereafter CSFR). This was 
done in the context of an initiative by the Group of Twenty-Four (G-24) to provide 
financial assistance supplementing that offered by the IMF and the World Bank. The 
objective of the loan was to ensure a sustainable balance of payments situation, strengthen 
international reserves and facilitate the introduction of currency convertibility. Together 
with a broadly equivalent contribution from the non-Community members of the G-24, the 
loan was supposed to cover the CSFR's balance of payments "financing gap" for 1991, 
estimated at US$ 1 billion. 
The loan was to be disbursed in two tranches. The release of the first tranche was made 
conditional upon the CSFR government reaching agreement with the IMF on a stand-by 
arrangement based on a comprehensive economic policy programme. With the IMF Board 
having approved a 14-month stand-by credit in January 1991, the first tranche (of ECU 185 
million) was effectively disbursed in August of that year. The disbursement of the second 
tranche was subject to a successful review by the European Commission, in consultation 
with the Monetary Committee, of progress in the field of economic stabilization and 
structural reforms, including the observance of a number of quantitative performance 
criteria agreed by the two parties. After a positive review, the second tranche (of ECU 190 
million) was released in February 1992. 
Regarding the assistance granted by the non-Community members of the G-24, US$ 384 
million were committed, mostly in the form of medium-term loans to the CSFR. Of this 
amount, US$ 362 million were effectively disbursed. 
In what follows, we review the situation after the full disbursement of the 1991 loan. 
Section 2 gives a brief description of economic performance and policies in the CSFR in 
1992, the year before the break-up of the federation. Section 3 then discusses the issue of 
the division of the EC loan between the two republics that succeeded the CSFR on 1 
January 1993. Section 4 analyzes the main economic repercussions of the dissolution of the 
federation and Section 5 spells out, for the Czech Republic and for the Slovak Republic 
separately, the main economic trends and policy measures of 1993. Finally, section 6 
makes an overall assessment of the situation and prospects in the two countries. 
2. Economic developments in the CSFR in 1992 
Real GDP in the whole of the former CSFR fell again by an estimated 7% in 1992, after 
decreasing by 15.9% in the previous year. However, over the year the decline of output 
was partially halted and in the second half of the year some sectors began to show signs of 
recovery. Despite the decline in output, registered unemployment fell steadily during 1992 
in both republics. For the whole of the CSFR, the unemployment rate fell from 6.6% at the 
end of 1991 to 5.1% at the end of 1992. Nevertheless, regional differences in the labour 
market remained pronounced: whereas, at the end of 1992 the unemployment rate stood at 
only 2.6% in the Czech lands, in Slovakia the rate was 10.4%. 
Supported by the continued implementation by the authorities of the CSFR of tight 
monetary and fiscal policies, average inflation slowed down to 12.7% in December 1992, 
after having reached 52% in December 1991 in the wake of the liberalization of prices. 
However, consumer price inflation picked up somewhat in the latter half of 1992, partly as 
a result of an acceleration of wage growth. In an attempt to compensate for the massive 
(25%) decline in real wages that took place in 1991, average wages rose by 17%, implying 
a real increase of about 8%. 
Having been almost in balance in 1990, the general government deficit in the CSFR swung 
into a deficit of 2% of GDP in 1991 and of 3.6% of GDP in 1992. This deterioration of the 
fiscal accounts is basically explained by the loss of revenue associated with the decline of 
-27-
economic activity and the erosion of the traditional state-enterprise tax base, as well as by 
the negative budgetary impact of several structural reforms. However, in comparison to 
the experience of other Central and Eastern European Countries in transition to a market 
economy, the deterioration of the fiscal situation in the former CSFR was very moderate 
and was in fact consistent with a tight underlying fiscal stance. 
The monetary programme adopted by the authorities for 1992 targeted a price inflation of 
12% during the year, which was consistent with a modest real increase of credit to 
enterprises and households. Despite the complications for monetary management 
introduced by the uncertainties associated with the impending dissolution of the federation, 
the objectives of the programme were broadly met, with inflation growing in 1992 by 
12.7% and broad money by 17.5%. Such uncertainties, however, resulted in quite divergent 
monetary trends in the Czech lands and Slovakia, with broad money growing at around 
23% in the former and around 4.5% in the latter. There was also significant changes, in the 
stance of monetary policy in the course of the year. Until August, the strong balance of 
payments position and the success in reducing inflation led the authorities to ease monetary 
conditions in an attempt to support economic activity. But from September onwards 
monetary conditions were tightened again as inflation showed some signs of accelerating 
and as fears about the repercussions of the split of the federation provoked an intense 
capital flight from both republics (as well as from Slovakia to the Czech lands). Thus, 
banks' reserve requirements were raised and auction refinancing credit rates climbed from 
14% to 20% by the end of December. 
From the beginning of 1991 to the dissolution of the federation, exchange rate policy was 
characterized by the use of the exchange rate as a nominal anchor of the reform process. 
This was reflected in the almost complete stability of the nominal exchange rate of the 
crown, which remained in effect fixed against a basket of five Western currencies. With 
consumer prices increasing by 54%» in 1991 as a result of that year's liberalization of prices 
and removal of subsidies, and with the inflation differential vis-à-vis the CSFR's main 
trading partners remaining positive in 1992, the stability of the nominal exchange rate 
translated into a substantial real appreciation. By the end of 1992, the CSFR had lost 
practically all the competitive edge gained through the 50% nominal devaluation 
engineered in 1990. 
Like monetary policy, the CSFR's balance of payments experienced very different trends in 
the first and second halfs of 1992. With exports to the West growing strongly despite the 
recession in European markets, and imports below expectations, the current account posted 
a US$ 0.7 billion surplus in the first half of the year. Furthermore, at US$ 2.1 billion, 
official hard-currency reserves at mid-year exceeded by US$ 1 billion the projections 
incorporated in the stand-by programme agreed with the IMF in April. By contrast, in the 
second half of the year uncertainties surrounding the division of the federation affected 
very negatively inflows of foreign direct investment (FDI), provoked, as noted, a capital 
flight and induced an increase in imports on concerns about future external relations 
between the two republics. Imports also accelerated at the end of the year due to the 
expectations of the introduction of the VAT in January 1993. All this resulted in a sharp 
reduction in official reserves to US$ 1.3 billion by year-end. For the whole of 1992, the 
convertible current account surplus fell from US$ 357 million in 1991 to US$ 330 million. 
Although the dissolution of the CSFR tended to dominate the political debate since the 
summer of 1992 and diverted some attention from structural reforms, progress in several 
areas continued to be made. Thus, the bidding rounds of the first wave of large-scale 
"voucher-privatization", involving 1.500 companies with a book value of about 50% of 
GDP, were completed in December of 1992. Under the voucher scheme, citizens 18 years 
or older were invited to purchase a booklet of vouchers worth 1000 points for a fee 
equivalent to one week's average wage. Individuals could use these points to bid for shares 
in companies being privatized or entrust them for management to the Investment 
Privatization Funds (IPFs), about 400 of which emerged spontaneously. In the event, about 
70% of the distributed points were handed over to the EPFs. 
Following the 1991 "big bang", some further deregulation of prices took place in 1992. 
Further progress was also made in the institutional and regulatory framework for the capital 
markets with the adoption of a Securities Act and a basic law to regulate the IPFs, and 
-28-
preparations to set up stock exchanges in both Prague and Bratislava (which would be 
eventually opened in 1993). The authorities of both republics also worked intensively last 
year in the design of a comprehensive tax reform which entered into force in January 1993 
and included the introduction of a VAT and a complete overhaul of direct taxation. 
Concerning the banking sector, bank regulation and supervision was strengthened by the 
adoption in February 1992 of new banking laws establishing capital adequacy regulations 
in line with BIS standards, as well as limits on large credit exposures and foreign excfiange 
positions. The main elements of these banking regulations have been broadly maintained 
by the new independent republics after the dissolution of the CSFR. Additional measures to 
improve the portfolio and capital position of banks were also taken by the federal 
authorities in 1992. 
In the area of foreign trade, the provisions on trade of the Association Agreement 
concluded with the Community in December 1991 became effective in March 1992 on the 
'basis of an interim agreement. The Association Agreement, which was replaced in October 
1993 by separate Agreements with each of the successor republics, aims at establishing a 
free trade area between the Community and the former CSFR in ten years. Regarding 
industrial goods, many of the remaining EC tariffs and quantitative restrictions were 
eliminated immediately after the agreement entered into force. For some sensitive 
industrial products and for most agricultural products, however, a less ambitious or more 
gradual liberalization was agreed. In March of 1992, the CSFR signed another trade 
agreement with the EFTA countries and in December of 1992 concluded the so-called 
"Visegrad Agreement" with Hungary and Poland, which aims at the gradual introduction of 
a free trade area among those neighbouring countries by the year 2000 at the latest. Like in 
the case of the European Agreement, the agreements with the EFTA and the other Visegrad 
countries have been replaced in 1993 by separate agreements for each successor republic. 
3. Division of the 1991 EC Loan 
In view of the institutional changes which led to the partitioning of the Czech and Slovak 
Federal Republic into two separate states, the Commission took the initiative to propose to 
the authorities of the CSFR and of the two successor republics in December 1992, and 
again in January 1993, that the loan be continued on the understanding that the two new 
republics would be jointly and severally liable towards the Community for the full amount. 
The authorities of both republics, however, declined on several occasions to accept the 
proposal made by the Commission and requested that the Community consider the 
possibility of individual liability of the Czech and the Slovak Republics, according to a 2:1 
ratio, consistent with their separation agreement. In justifying their position, the new 
republics emphasized the fact that individual responsibility is one of the most important 
aspects of sovereignty, and that economic autonomy was a crucial factor in the separation 
of the Czech and Slovak Republics. They also argued that some other important official 
creditors had already accepted separate liability of the successor states. 
After consultation of the Monetary Committee, the Commission agreed to go along the 
Czech and Slovak request and adopted in August 1993 a proposal for a Council decision 
designed to establish the principle of the split of the 1991 EC loan to the CSFR according 
to the 2:1 ratio, with each successor Republic being individually liable for only its allocated 
part of the loan. Accordingly, the Czech Republic and the Slovak Republic will be 
responsible for, respectively, two thirds and one third of the total payments of principal, 
interest and fees associated with the EC loan. After consultation of the Parliament, the 
proposal was formally approved by the Council on January 24, 1994. It empowers the 
Commission to agree with the national authorities of the two republics on the necessary 
adjustments to the original Loan Agreement. 
Finally, it must be noted that since the partition of the federation the authorities of both 
republics have been discharging fully and timely the interest payments associated with the 
1991 loan. 
-29-
4. Economie implications of the dissolution of the CSFR 
Following the general elections of June 1992, the governments of the two republics decided 
to dissolve the federation by the end of the year. They then proceeded to agree on the 
division of federal assets and liabilities. Fixed properties would be divided according to the 
territorial principle and most other assets and liabilities according to a 2:1 ratio that 
reflected the relative population shares of the two republics. 
In order to avoid excessive disruptions in economic relations between the two republics 
after the separation, the respective governments also agreed to set up a customs and 
monetary union between the two countries starting on 1 January, 1993. The customs union 
guaranteed the free movement of goods and services between the two republics, prohibited 
the use of tariff and non-tariff barriers within the territory of the former CSFR, and 
stipulated identical custom policies vis-à-vis third countries. Capital and labour would also 
be allowed to circulate freely between the two countries. As for the monetary union, it was 
envisaged to last at least six months but could be dissolved earlier under certain conditions, 
including a sharp decline in international reserves or bank deposits in any of the two 
republics. 
Nevertheless, uncertainty about the consequences of the break-up of the federation and 
speculation about the future of the monetary union (which was seen as a transitory 
agreement) soon gave rise to a strong capital flight out of both republics and out of 
Slovakia and into the Czech lands (on expectations of a devaluation of the Slovak crown 
against the Czech crown). This produced large losses bf foreign exchange reserves in both 
republics and provoked the collapse of the monetary union at the beginning of February, 
that is, only a month after it was set up. 
The introduction of new currencies, initially through the attachment to the notes of 
different stamps in each republic, proceeded smoothly. The conversion against the old 
Czechoslovak currency was effected at par for both the Czech crown and the Slovak crown. 
In order to minimize possible disruptions of trade after the split of the currencies, the 
authorities of both countries introduced a bilateral settlement system for inter-republican 
transactions. Payments between the Czech Republic and the Slovak Republic are now 
centralized through two clearing accounts. Payments arising from post-8 February 
transactions are settled through an account denominated in "clearing ECUs", with balances 
being settled in hard-currency at the end of the month and only to the extent that they 
exceed ECU 130 million. While, in principle, one clearing ECU is equivalent to one ECU, 
the exchange rate of both national currencies in terms of the clearing ECU are allowed to 
deviate by + 5% from their exchange rates against the actual ECU. Inter-republican 
payments arising from pre-8 February transactions are settled through a different clearing 
account denominated in the so-called "Czechoslovak Accounting Crown". Balances in this 
second clearing account are regularly settled either in hard-currency or by transferring them 
to the ECU-based account. 
Despite the establishment of the bilateral clearing system and the maintenance of the 
customs union, inter-republican trade fell sharply (by about 45%) in the first quarter of 
1993. Although bilateral trade turnover has recovered somewhat since then, inter-
republican trade is estimated to have declined by around 20% in 1993 as a whole. 
The split of the federation and the subsequent demise of the monetary union between two 
republics has had a much more adverse impact on Slovakia than on the Czech Republic. 
First, the dissolution of the CSFR has put an end to the very considerable fiscal transfers 
that Slovakia used to receive from the Czech Republic through the federal budget. This, in 
turn, has unmasked an important Slovak current account deficit vis-à-vis the Czech 
Republic. Second, with the separation, Slovakia has also lost much of the federal 
government's solid reputation for orthodox macro-economic policies and market-oriented 
reforms, a reputation that has in effect been inherited by the Czech Republic. Third, with 
most federal institutions being located in the Czech Republic and many of the better 
qualified professionals remaining in the newly-created Czech institutions, Slovakia's 
economic policy has been impaired by the lack of proper institutions and human capital. 
(5) 
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To the comparatively worse repercussions of the division of the CSFR on the Slovak 
Republic must be added the less favourable economic situation that already prevailed in 
Slovakia before the division. At the end of 1992 Slovakia had not only an average rate of 
unemployment four times higher than that of the Czech Republic but also a weaker 
industrial structure and a greater share of the defense and heavy industries that had most 
suffered from the collapse of the CMEA traditional markets. 
5. Economic developments in 1993 
5.1. The Czech Republic 
Real GDP in the Czech Republic is estimated to have grown moderately in 1993 (between 
0 and 1%), the first positive rate since real output began declining in 1990. Real GDP 
(seasonally adjusted), has been growing since the second quarter of 1993, spurred both by 
the recovery of consumption and investment and by a surprisingly strong performance of 
convertible exports. 
With banks and other creditors continuing to refuse to apply effectively the April 1993 
bankruptcy law, the unemployment rate has remained at very low levels (3.5% at end-1993, 
only moderately up from the 2.6% rate prevailing a year before). 
Following a 8.5%» price jump in January 1993 associated with the introduction in that 
month of the VAT, inflation came down rapidly to about 0.5% per month in March-July. 
Inflation, however, accelerated again between August and October as a result of unusually 
large food price increases and ended the year at 18.2%, above an initial target of 14-16% 
and the 12.7% rate recorded in December 1992. The main threat to inflation continues to be 
the rapid growth of wages. Although wage increases moderated somewhat after the 
reintroduction by the Czech authorities on July 1, 1993 of a tax on excessive wage 
increases, they have remained very high. Thus, in the third quarter of 1993 nominal wages 
in enterprises with 25 or more employees were 26% higher than in the same quarter of 
1992. 
Speculation against the currency, unfavourable wage and price developments and the need 
to drain the excess bank liquidity that resulted from the conversion of cash holdings and 
bank deposits ahead of the currency split, led the Czech National Bank to tighten monetary 
policy in the first months of the year. However, since the end of April 1993, as trends in 
currency in circulation began to reverse, foreign exchange reserves increased and inflation 
started to show a positive behaviour, monetary policy has been gradually eased. Regarding 
fiscal policy, the state budget recorded in 1993 a Kc 1.1 bn surplus, representing 0.1%» of 
GDP. Together with an unexpectedly strong financial position of the local authorities, this 
has resulted in a general government deficit close to zero, against the 1% of GDP deficit 
target that had been agreed with the IMF. 
The Czech current account (excluding transfers to Slovak citizens of shares in enterprises 
privatized in the first wave of voucher-privatization) is tentatively estimated to have posted 
in 1993 a surplus of some US$ 600 million, or about 1.9% of GDP. This is a surprisingly 
good result given the acceleration of domestic demand and imports and the weakness of the 
Czech Republic's main export markets. In contrast with the sharp drops in exports suffered 
by other Central European countries, Czech exports (excluding exports to Slovakia) 
performed strongly, growing by 13% in real terms in the first 10 months of 1993. 
Although the net inflow of foreign direct investment slowed down in 1993 to US$ 450 mio 
(from US$ 983 mio in 1992), the Czech Republic has been experiencing a surge in other 
capital inflows since the third quarter of 1993. Thus, net portfolio investment (to a large 
extent in the form of equity purchases) reached in 1993 about US$ 700 mio and Czech 
enterprises borrowed abroad US$ 750 mio (basically in the form of bank credits). 
Furthermore, the Czech National Bank successfully placed several international bond issues 
last year. This relatively high degree of access of the Czech Republic to the international 
capital markets has been reinforced by the upgrading of Moody's rating (from the Bal 
previously assigned to the CSFR to Baa3) and by the assignment by Standard and Poor's of 
a comparable BBB rating. This makes the Czech Republic the only Eastern European 
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country to have been issued an "investment grade" mark by the lending international rating 
agencies. 
The combination of a healthy current account position and a strong capital inflow has put 
upward pressure on the nominal exchange rate and has resulted in a rapid growth of official 
foreign exchange reserves, which stood at US$ 3.8 bn at end-1993, compared to US$ 0.7 
bn at end-1992. In order to stem the upward pressure on the exchange rate, the Czech 
National Bank is planning to make the crown fully convertible for current account 
transactions and to liberalize in a phased manner controls on capital outflows. 
Despite recent speculation on a possible revaluation of the Czech crown, the currency has 
remained stable against the reference basket of Western currencies used to peg its value. As 
of May 1993, the number of currencies in the basket was reduced from 5 to 2 (the US$ and 
the Deutsche Mark). This has strengthened considerably the link of the crown to the 
German currency. The persistence of a significant price and wage inflation differential 
between the Czech Republic and its main trading partners has continued to appreciate the 
real exchange rate, which stands now at a level similar to that which prevailed before the 
1990 devaluations. 
The IMF approved a 12-month, SDR' 177 mio stand-by credit to the Czech Republic in 
March 1993. Granted in the wake of the speculation and sharp decline in reserves that 
accompanied the dissolution of the CSFR, the credit aimed at providing an early boost to 
reserves and helping the Czech authorities reestablish international confidence in its 
policies. With the external situation improving rapidly in the course of 1993, the Czech 
authorities only made the first purchase under the stand-by arrangement (SDR 70 mio) and 
repurchased this amount ahead of schedule in September 1993. 
The Czech Republic has continued to make progress on the structural side. With last 
spring's distribution of enterprise shares, the first wave of large-scale privatization was 
completed. Moreover, a second wave of large-scale privatization is already underway. As 
was the case in the first wave, almost one third of the assets, with an estimated book value 
of Kc 145 billion will be sold through the voucher method. The distribution of vouchers 
began in October 1993 and the first bidding round is expected to start in April of this year. 
The second wave should be completed by end-1994, by which time about 90% of the assets 
of the economy will be in private hands. 
The implementation of bankruptcy legislation was originally planned for October of 1992 
but was delayed for fear that an excessive number of bankruptcies could boost 
unemployment, thwart the recovery of the economy and clog-up the court system. In April 
of 1993, the bankruptcy law finally came into effect, following an amendment that allows 
three months for creditors to attempt to reach an agreement before a bankruptcy procedure 
is initiated by the court. Contrary to expectations, however, the number of companies filing 
for bankruptcy procedures since the law came into effect has been relatively small. 
Regarding the reform and development of the financial system, the Prague Stock Exchange 
started operating in April 1993 and the banking laws inherited from the CSFR have been 
slightly modified to strengthen banking supervision. In addition, part of the privatization 
proceeds have been earmarked by the National Property Fund to purchase bad loans in the 
banks' portfolios at a discount. 
5.2. The Slovak Republic 
Slovak real GDP is estimated to have declined by 5-7% in 1993, implying the fourth 
consecutive year of recession. Unemployment, for its part, has kept climbing, reaching 
14.4% of the labour force at end-1993, up from 10.4% at end-1992. 
The prolongation of the Slovak recession is largely explained by the negative effects the 
dissolution of the CSFR has had on Slovakia. The split of the CSFR not only has disrupted 
trade with the Czech Republic, but has also obliged the Slovak authorities to pursue 
restrictive macro-economic policies. Monetary policy had to be overly tight in the first half 
of 1993 in order to defend the country's foreign exchange reserves amid persistent 
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* 
speculation about a devaluation of the Slovak crown. While the monetary stance was 
gradually eased after the July devaluation, the reemergence of pressures on the exchange 
rate at the end of 1993 obliged the National Bank of Slovakia (NBS) to raise the discount 
rate from 9.5% to 12% on December 21. On the fiscal front, the authorities have made a 
significant effort to control the budget deficit after the termination of the fiscal transfers 
from the Czech lands. In particular, the government adopted in the summer of 1993 a tough 
package of fiscal measures (including an increase in the VAT) aimed at cutting the deficit 
by 2.5% of GDP in the second half of the year. Although the general government is 
estimated to have run a deficit of about 7% of GDP last year, this would mean a substantial 
correction from an estimated budget deficit before Czech transfers of 14% of GDP in 1992. 
The increases in indirect taxation and the 10% devaluation of the Slovak crown in July 
1993 have resulted in an increase in CPI inflation from 12.7% at end-1992 to 25.1% at end-
1993. 
The loss of the fiscal transfers from the Czech Republic was expected to unmask a large 
deficit in the Slovak current account. In the event, however, the sharp compression of 
domestic demand and imports and the devaluation of the Slovak crown have avoided the 
emergence of a too serious current account deficit. Thus, excluding transfers from the 
Czech Republic associated with the distribution of voucher-shares to Slovak citizens, NBS 
data show a total current account of US$ 289 mio (or 2.9% of GDP) in the first 10 months 
of 1993. 
Slovakia is, however, having problems to finance even this smaller-than-expected current 
account deficit. First, at an estimated US$ 100 mio in 1993, net foreign direct investment 
continues to be of little significance. Second, Slovakia lacks good access to the 
international capital markets. Slovak borrowers have placed only two international bonds 
since the break-up of the CSFR2 and in both cases paying quite high spreads over Libor. 
Third, speculation about a devaluation of the Slovak crown has resulted both in the first 
half of 1993 and since the end of that year in a significant outflow of short-term capital. 
To help ease its balance of payments constraint, the IMF granted to Slovakia an SDR 64,35 
mio (US$ 89 mio) Systemic Transformation Facility (STF) loan in July 1993. The IMF is 
also about to reach agreement with the Slovak authorities on an economic policy 
progamme that could be supported in the coming months by a stand-by arrangement and, 
possibly, a second purchase from the STF. In addition, the World Bank approved in 
November 1993 a US$ 80 mio Economic Recovery Loan. It can also be expected that 
further macro-financial assistance from the G-24 will eventually be requested to 
supplement the IMF and World Bank loans. 
The weakness of Slovakia's balance of payments has been reflected in a very vulnerable 
foreign exchange reserve position. Capital flight in early 1993 practically depleted official 
hard-currency reserves, which (excluding gold and SDR holdings) fell from approximately 
US$ 350 mio at end-1992 to US$ 119 mio at end-February 1993. This led the authorities to 
restrict current account convertibility. Thus, in late January banks were obliged to increase 
their overall short position in foreign currency to 35% of their capital before they could 
buy foreign exchange from the NBS, and in February minimum financing requirements for 
imports were introduced. Between May and September official foreign exchange reserves 
recovered gradually, reaching US$ 513 mio at end-September. Much of the increase, 
however, reflected the STF purchase and the international bond issued by the NBS in 
September. Furthermore, since the second half of October the NBS has again been losing 
reserves. In spite of this, the authorities decided to remove the restrictions on convertibility 
introduced in early 1992. Official foreign exchange reserves stood at US$ 415 mio (or 
about three weeks of imports) at the end of 1993. 
Regarding exchange rate policy, the currency continues to be pegged to a basket of five 
Western currencies. The Slovak crown was devalued by 10% against convertible currencies 
A US$ 240 mio bond issued by the SNB in September 1993 and a US$ 21 mio bond issued by Calex, a state-
owned manufacturing company, in January 1994. 
- 33 -
last July. This was done in the context of the adjustment programme agreed with the IMF 
and supported by the STF purchase. Furthermore, the Slovak crown was devalued by 5% 
against the clearing ECU in early December 1993. Given the almost simultaneous 3% 
revaluation of the Czech crown against the clearing ECU, this means that, since the split of 
the currencies and with respect to inter-republican transactions, the Slovak crown has been 
devalued by about 18% against the Czech crown. 
Concerning structural measures, with the first wave of large-scale privatization completed 
last spring, the Slovak government is now preparing a second wave including some 650 
enterprises. In contrast to the first wave (and the second Czech wave), however, the Slovak 
government intends to rely primarily on traditional privatization methods, such as direct 
sales to investors, "management buy-outs" and tenders. Coupon privatization will still be 
used but in a much smaller scale than before. The aim of this shift to more conventional 
methods is both to increase badly-needed state and foreign exchange revenues and to make 
sure that enterprises are transferred to capable owners. 
A bankruptcy law finally entered into effect in June 1993, following-(like in the Czech 
case) an amendment under which a board of creditors will have three months to work out a 
rehabilitation plan. The Slovak government has also initiated an operation to net out part of 
the inter-enterprise arrears. At a first stage, the operation was concluded on a voluntary 
basis but, in order to achieve a further reduction of inter-enterprise arrears, the government 
has recently decided to make enterprise registration of claims obligatory. 
Finally, regarding financial sector reform, Slovakia is preparing some amendments to the 
banking laws and regulations inherited from the former CSFR and is elaborating a strategy 
to strengthen the balance-sheets of the major Slovak banks, probably with the support of 
the EBRD and the PHARE programme. 
6. Assessment and prospects 
As noted in the 1992 Report, by helping to close the estimated balance of payments 
"financing-gap" at a crucial moment in the country's transition towards a market-economy, 
EC macro-financial assistance to the former CSFR has contributed to the success of the 
CSFR's stabilization and reform programmes. Without the G-24/EC balance of payments 
support, the cost of the transformation process in terms of output lost and unemployment 
would have been significantly higher and, perhaps, unacceptable to the population. G-
24/EC macro-financial assistance eased the CSFR external constraint both directly and by 
helping the country to gain access to the international private capital markets. 
Since the presentation of the previous Report, progress has continued to be made in both 
republics in the major areas of structural reform. On the macro-economic front, the Czech 
Republic has continued to implement sound and orthodox fiscal and monetary policies. As 
a result, inflation has been brought back under control following last January's VAT-
induced price-jump, and official reserves have been rebuilt to very comfortable levels. 
Also, the projected current account deficit will be amply financed by expected inflows of 
foreign direct investment and other private capital inflows. 
The Slovak Republic faces, as noted, a more difficult macro-economic situation. First, the 
loss of large fiscal transfers from the Czech Republic has resulted in an important budget 
deficit and, although a serious current account deficit will probably be avoided, the Slovak 
recession has proved to be deeper and longer than was initially expected. Second, the recent 
devaluation of the Slovak crown and a new increase in indirect taxes has complicated the 
fight against inflation. Third, official reserves remain at a very low level and Slovakia has 
limited access to the international capital markets. However, recent measures like the tough 
emergency fiscal package adopted by the Slovak government last summer, and the rigorous 
monetary policy implemented since the beginning of 1993 confirm the high priority that 
the Slovak authorities continue to attach to the stabilization of the economy. 
The dissolution of the federation has had negative repercussions on both the Czech and the 
Slovak economy, compounding for the latter the difficulties of the transition process. But 
both countries seem committed to the structural reform programmes and are taking the 
-34-
right steps to ensure that the reforms continue to be backed by a stable macro-economic 
framework. 
-35-
IV. BULGARIA 
1. Introduction 
The radical economic reform process in Bulgaria started in early 1991 when the country's 
first non-communist government embarked on an ambitious stabilization and reform pro­
gramme under which tight macro-economic policies were put in place and several 
important structural reforms were undertaken. In support of the programme, the IMF con­
cluded with the authorities a twelve-month Stand-by arrangement in March 1991 providing 
for up to some US$ 390 million, with an attached contingency mechanism for oil and gas 
prices, under which approximately US$ 80 million was drawn. The World Bank was to 
make available a Structural Adjustment Loan (SAL) of US$ 250 million. The Group of 
Twenty-Four pledged complementary financial assistance of some US$ 600 million, 
including a Community loan of ECU 290 million (disbursed in two tranches, in August 
1991 and March 1992). 
As noted in the previous report, the results of the policies implemented in 1991 were 
satisfactory : price distortions were decisively addressed; trade and exchange systems were 
liberalized; and some important institutional and legislative changes were introduced. 
Several key structural reforms, in particular land reform and enterprise restructuring and 
privatization, proceeded, though more slowly than planned owing mainly to political uncer­
tainties. 
The programme for 1992-1993 was designed to achieve further progress towards a viable 
external financial position to secure a stable domestic financial framework with low 
inflation and increased financing of the non-government sector, and finally to reduce the 
fall in output mainly through the continuation of the structural transformation of the 
economy. The programme was in particular intended to make a decisive start on the long 
delayed ownership reform. 
The financing needs associated with the programme were estimated at US$ 2.6 billion, 
down from US$3.8 billion a year earlier. They were assumed to be met, like in 1991, 
through debt rescheduling (with the Paris Club of official creditors) and roll-overs (with the 
commercial banks), and through official assistance from the International Financial 
Institutions and the Group of Twenty-Four. In particular, the programme was supported by 
a new twelve-month Stand-by arrangement with the IMF (concluded in April 1992) under 
which Bulgaria would be able to purchase up to some US$ 215 million, and the second 
tranche of the World Bank 1991 SAL (US$ 100 million). The G-24 was requested to pro­
vide new complementary financing of US$240 million. In the context of the 1992-93 
assistance package, the Community decided to grant Bulgaria a new loan of ECU 110 mil­
lion (Council decision 92/511/EEC of 19 October 1992) which represented approximately 
50% of the residual financing gap. However, the IMF supported programme went off-track 
and the Community loan has not been disbursed. 
2. Macro-economic developments and policies in 1992-1993 
In the first half of 1992, the Bulgarian authorities continued to implement tight macro-eco­
nomic policies, and achieved further progress towards stabilization. In mid-1992, though, 
the government came under strong criticism from the opposition, the trade unions and the 
industrialists for mishandling the economic reform and in particular for neglecting to ad­
dress decisively the needs of the enterprise sector (by the end of 1992, half of Bulgaria's 
state and municipal enterprises were operating at a loss) and for proceeding too slowly with 
privatization. As political opposition to the stabilization programme was growing, macro-
economic management weakened in the second part of the year and most programme 
targets for fiscal, monetary and incomes policies were missed. As a result, Bulgaria was not 
in a position to draw the last tranche under the SBA (some US$ 43 million). 
In late October 1992, the centre-right Union of Democratic Forces government had even­
tually to step down. A new, non-party, government, backed by a heterogeneous coalition of 
the Socialist Party, the Movement for Rights and Freedom and a fraction of the UDF, came 
-36-
to power on 30 December 1992. From the outset, this government placed an emphasis on 
structural reforms, in particular on privatization. At the same time, it was not prepared to 
take unpopular economic policy measures. The new authorities did not implement strict fis­
cal policies, and therefore failed to conclude in 1993 the discussions with the IMF on a new-
financing arrangement. The World Bank, on its part, withheld the disbursement of the sec­
ond tranche of the 1991 SAL. 
2 1 Macro-economic policies 
The fiscal policy intended to be implemented in 1992 was aimed to limit budget financing 
and credit to state enterprises to make financial resources available for the growing private 
sector. In particular, the budget deficit was intended to be limited to 4.5% of GDP. 
From July 1992, government spending increased beyond targets due to wage, social assis­
tance and defence spending overruns. The adjustment of energy prices, that would have 
broadened the energy sector profits tax base, failed to materialize. Meanwhile, the financial 
performance of the state sector continued to deteriorate, bringing about a structural decline 
in tax revenues. For the year as a whole, the fiscal deficit was thus close to 7% of GDP. In 
1993, fiscal policies remained lax; the budget deficit increased further, approaching 11% of 
GDP. 
Monetary policy reflected the fiscal stance. In the first half of 1992, the monetary 
authorities respected the targets for money creation that had been agreed with the IMF. 
Growth of domestic credit to government was contained to 6% in the first six months, 
against an increase in the general price level of almost 40%. In the second half of the year, 
it almost doubled; the resulting increase in the general government's monetary financing by 
more than 110% far exceeded the targets of the economic programme. Credit expansion to 
government crowded out the private sector. 
Restrictive incomes policy had been one of the essential components of the government's 
stabilization programme since February 1991. Its relaxation in July 1992 when the govern­
ment raised minimum wages and wages of state employees was one of the main causes for 
inflation in the second part of the year. Average real wages rose by about 12% in 1992. In 
1993 (on 1 April), wages of public sector employees were increased by 44% and a new 
wage indexation system which reflected nearly 100% of price increases and thus perpetu­
ated inflation. 
2.2. Economic results 
GDP fell by about 6% in 1992 (after a drop of some 12% in 1991). Industrial production 
declined by around 11%), as compared to 18.6% the previous year. The services sector de­
clined much less (around 3%) and began to show signs of recovery, thanks to private sector 
activity, especially in retail trade. Agricultural production declined by about 7%. For 1993, 
GDP decline is estimated at 3 to 4%. 
As a result of depressed activity and labour shedding in the state sector, unemployment 
rose during 1992 and early 1993, from 10%» to 16%, the highest level in all of Eastern 
Europe. It has remained stable at around this level since. Private sector employment, 
however, recorded a dramatic rise. It is estimated that by the end of 1992 the private sector 
accounted for some 14% of total employment. "Side income" (various forms of income 
from the private sector) is estimated by the authorities to have greatly risen and to have 
become the second largest source of household income by end 1992. These trends 
continued in 1993. 
The monthly inflation rate fell to 2% in July 1992, but rose again to 5-6% by the end of the 
year. The annual inflation rate was 91% in 1992. In 1993, the year-on-year inflation rate 
decreased to 73%» (end-year inflation in 1992 and 1993 was 79% and 64% respectively). 
After the initial sharp devaluation following the exchange system reform in February 1991, 
the lev gradually depreciated from around 18 per dollar in April 1991 to 27 per dollar by 
August 1993 This nominal depreciation of the Bulgarian currency represents in fact a strong 
-37-
real appreciation. In the last months of 1993, however, the national currency came under 
strong pressure and the exchange rate depreciation accelerated. By the end of 1993, the ex­
change rate of the lev was about 32 per dollar. 
2.3. External Developments 
The structural shift in foreign trade from the former CMEA countries to the Western in­
dustrialized countries continued in 1992 from the previous year. Exports in convertible cur­
rencies rose by 30% (reflecting a competitive exchange rate, low labour costs and a more 
liberal trade regime), while those to former CMEA countries halved in 1992. According to 
national statistics, trade with the EC increased particularly rapidly, with both exports and 
imports doubling. EC trade is expected to receive a further boost through the recent Interim 
Agreement, which came into force on 31 December 1993. 
The trade account was balanced in 1992, but it is likely to have recorded a significant 
deficit in 1993, estimated at US$0.5 billion. This is due not only to reduced external 
competitiveness, following wage increases and real appreciation of the lev, but also to 
recession in the EC export markets and to UN trade sanctions against rump Yugoslavia 
(Serbia and.Montenegro). The sanctions, imposed in May 1992 and made more severe in 
April 1993, not only bar exports to Serbia and Montenegro, but also disrupt trade with 
Western Europe by blocking transport links. The Bulgarian authorities allege that they cost 
the country US$ 240 million a month between lost exports and increased transport costs. 
Latest IMF estimates of the effect of the sanctions on Bulgaria's current account point to a 
loss of up to US$ 400 million in 1992 and US$ 700 million in 1993. 
Smaller than expected official capital inflows have been more than offset by private in­
flows, mainly related to export receipts and repatriation of capital due to high returns on 
leva denominated domestic financial assets. The Bulgarian National Bank could thus 
increase its international reserves to close to US$ 1 billion, equivalent to over three months 
of merchandise imports. By the end of 1993, the reserves were much lower (some US$ 700 
million) due in particular to the interventions of the BNB in support of the national 
currency on the foreign exchange market. Foreign direct investment remained, however, 
extremely low (some US$ 40 million in 1992 and US$ 20 million in the first half of 1993), 
despite a particularly liberal law passed in January 1992 allowing foreign investment in 
virtually all sectors of the economy. 
In order to secure deferral and rescheduling of external debt servicing obligations on of­
ficial debt, in December 1992 Bulgaria reached an agreement with the Paris Club of offi­
cial creditors. This agreement that covered maturities falling due until April 1993 was the 
second agreement of this type (the first one was concluded in April 1991). A new official 
debt rescheduling will need to be negotiated as soon as Bulgaria has reached an 
arrangement with the IMF. 
In parallel Bulgaria was negotiating a comprehensive restructuring of its private debt (the 
bulk of the debt is owed to some 300 commercial banks). In November 1993, after three 
years of ups and downs in these negotiations, the authorities and the banks' advisory com­
mittee virtually agreed on the parameters of a comprehensive debt and debt-service re­
duction scheme (an agreement in principle on the main orientations of the scheme had al­
ready been reached in November 1992). According to the agreement, Bulgaria's 
commercial debt (approximately US$ 7.3 billion, in principal) will be substantially reduced 
through a mix of debt cash buy-backs and long-term securities (discount bonds at 50%» of 
face value and front-loaded interest reduction bonds). The agreement foresees separate 
treatment of interest arrears (some $2 billion), through buy-backs, cash payments and long-
term bonds. The deal, however, will have a high cost for Bulgaria: up to US$ 900 million 
up front, which is more than all of the Central Bank's international reserves, and US$ 280 
million per year in terms of debt servicing in the first years of restructuring (substantially 
more than Bulgaria had been paying since the last months of 1992 when it started making a 
portion of current interest payments as a goodwill gesture; such payments were, however, 
discontinued later to be resumed only in December 1993). 
-38-
3. The structural reform process in 1992-1993 
3.1. Liberalization 
After the extensive price liberalization at the onset of the reform programme,, controls had 
remained at the end of 1991 only for prices of energy and agriculture products In the 
course of 1992 and 1993, despite repeated nominal increases, most energy prices 
(electricity, heating and coal) were still below cost. Only the prices of petroleum products 
are virtually liberalized, since they are adjusted monthly on the basis of a formula that links 
them to world prices. The number of agricultural products subject to price restriction was 
reduced in May 1992. It is estimated that some 85 to 90% of all retail turnover takes place 
under free prices. 
In the area of foreign trade liberalization, the tariff system was modified in July 1992 with 
a new, simplified set of tariffs being introduced. Under the new system, the maximum tariff 
is 40% and the (unweighted) average tariff 18%. By comparison, Czechoslovakia, Hungary 
and Poland all had average unweighted tariffs between 9 and 14% in 1992. The average 
weighted tariff in Bulgaria in 1992 was 10.6%. Restrictions on exports, for the most part 
removed at the beginning of 1991, remained low by international standards despite the re-
introduction of quantitative restrictions on a small number of products in July 1992 and 
January 1993, as in particular licensing requirements for a number of agricultural goods 
were replaced by export taxes. 
3.2. Enterprise restructuring and privatization 
The structural reform programme, that was launched at the beginning of 1991, recorded 
significant progress in the first half of 1992 when a number of important measures was 
adopted. Between December 1991 and February 1992 legislation was enacted allowing the 
restitution of shops and small businesses to the former owners. The law on privatization of 
agricultural land was finally revised in April 1992 and by the end of 1993 about 40% of ag­
ricultural lands was restituted. Following the implementation of the 1991 Company Act, 
two thousand large state-owned industrial enterprises were transformed into commercial 
companies with the state as single shareholder by November 1992. In April 1992, a 
comprehensive law was passed on the privatization of both small and large state owned 
enterprises, and in September a programme to privatize 1600 companies was announced. 
Although these measures were implemented at a lower pace than initially envisaged 
(mainly due to lack of political consensus), by end-1992 a new, dynamic sector of small 
retail and service enterprises emerged, especially in the cities: by that time, 46% of 
property had been returned to its original owners. Overall, it is estimated that the private 
sector contributed 50%» of the total retail and wholesale trade in 1992, and between 15 and 
30% of total value added in the Bulgarian economy. 
33. Financial sector reform 
Financial sector reform continued in 1992 with the adoption of a Law on Banks and Credit 
Activity. The legal framework for the creation of a modern banking system is now in place, 
including an independent central bank and a private banking sector. In September 1992, the 
Bulgarian National Bank also introduced new payment and clearing arrangements. A 
second stock exchange was created in early 1992, dealing with small but rising amounts of 
shares. By mid-1993, the two stock exchanges together traded several million leva per 
week. 
Despite these achievements, many critical problems of the financial sector remained largely 
unresolved, and the banking system is still in dire need of modernization and recapitaliza­
tion. Bank assets comprise many non-performing loans to enterprises; partial clean-up op­
erations of bad debts that have taken place in the past and are to be implemented in 1994 
(following the adoption of a law on pre-1991 debts) are still insufficient to restore the com­
mercial banks' balances. The state enterprise sector is weak and debt-ridden (inter-
enterprise debt may account for about one-quarter of the value of industrial production). 
-39-
Budget constraints on enterprises remain too soft, partly because no effective bankruptcy 
provisions exist yet. This lack of adequate bankruptcy legislation and banking supervision 
(prudential regulations were only adopted by the second half of 1993) allows unprofitable 
enterprises to absorb a large share of domestic savings, thus reducing the scope for invest­
ment and development of private enterprise. Some progress has been made with the re­
structuring of the banking system, but the consolidation of the existing commercial banks 
into a small number of viable units was still not completed. A process of gradual 
recapitalization of the banks progressed only slowly, owing to its budgetary cost. 
3.4. Institutional strengthening of public finances 
In the second half of 1993, with the adoption by parliament of new tax laws (on VAT, in­
come tax and profit tax), the new taxation system whose foundations had been put in place 
as early as in 1991 was virtually completed. Together with the laws on budget procedure 
and on tax administration, the adoption of new laws are viewed as an important step 
towards institutional strengthening of public finance. 
4. Community macro-financial assistance in 1992-1993 and prospects 
The ECU 110 million Community loan was to be disbursed in two tranches, the disburse­
ment of each tranche being subject to a number of specific conditions. In particular, in view 
of significant delays in implementing the 1991 G-24 assistance package (often due to inef­
ficiencies on the Bulgarian side) and the uncertainty over the outcome of the negotiations 
on the restructuring of the country's foreign debt, two specific conditions were attached to 
the release of the first tranche of the loan: (i) the Bulgarian authorities had taken the 
necessary steps to allow the release of the amounts committed by the non-Community G-24 
members in the context of the 1991 support package, and (ii) an agreement in principle had 
been concluded between Bulgaria and its commercial bank creditors on a set of guidelines 
regarding a future debt restructuring deal. The second tranche was to be disbursed when 
decisive progress had been made towards a comprehensive medium-term commercial debt 
restructuring, and subject to a positive assessment by the Commission of progress in the 
field of economic stabilization and reform, on the basis of precise criteria that were to be 
specified in a Memorandum of Understanding. 
By the end of 1992, Bulgaria had completed the negotiations on the assistance with most 
members of the G-24 that had made commitments in 1992; it had also reached an under­
standing with the commercial creditors on the parameters of a future debt restructuring 
package. The implementation of the Community assistance was, however, delayed as the 
1992 stand-by arrangement with the IMF went off track and the authorities started negotiat­
ing a new financing programme with the Fund. For the same reason, no other G-24 
assistance .has been disbursed so far under the 1992-93 complementary package. 
The situation did not change during most of 1993 as the discussions on a new IMF-sup­
ported programme could not be concluded. However, at the very end of 1993, two impor­
tant developments took place that basically restored conditions for the resumption of 
Community and G-24 assistance to Bulgaria. An agreement on the restructuring of the 
commercial debt was reached that regularizes Bulgaria's position as a debtor and clarifies 
its medium-term financing needs; and a new stand-by arrangement with the Fund was 
agreed in principle. 
-40-
V. ROMANIA 
1. Introduction 
In July 1991, the Council of Ministers decided to grant Romania a first medium-term 
financial assistance of ECU 370 million in the context of an initiative by the G-24 aimed at 
providing a total of US$ 1 billion in assistance. This initiative supported a comprehensive 
reform programme aimed at stabilizing the economic situation and initiating the process of 
transformation from a highly centralized planned system to a market-oriented economy in 
the aftermath of the long period of political turmoil that had followed the collapse of the 
Ceauscescu regime. The financial assistance from the EC/G-24 was complementary to an 
IMF stand-by arrangement. 
'As reported in the previous report , despite progress in liberalizing the economy, the main 
stabilization objectives of the authorities' macroeconomic adjustment programme for 1991 
could not be achieved. Output declined substantially (by some 13 percent). Inflation 
accelerated late in the year and reached some 20 percent per month in January 1992, 
reflecting both the sharp depreciation following the unification of the exchange rate in 
November and the accommodating credit policy resulting from the rapid build-up of inter-
enterprise payments arrears. External reserves were depleted. The shortfall in non-
Community pledges and the resulting delays in the disbursement of external assistance was 
in part responsible for these slippages, especially with regard to the international reserve 
objective. 
Drawing on the experience of 1991, the Romanian authorities designed a new programme 
for 1992, that aimed to re-establish macroeconomic stability while developing the reform 
process. With regard to stabilization policy objectives, the authorities intended to slow the 
decline in real economic activity (to 5 percent), to lower the rate of inflation sharply (to 1.5 
percent per month by year end); and to increase international reserves (to 1.7 months of 
imports by year end). To achieve these objectives, the authorities intended to pursue strict 
fiscal and monetary policies, a tight incomes policy and a flexible exchange rate. Structural 
reform measures included further price liberalization, privatization and financial discipline 
through restructuring state enterprises. 
To Support the Romanian economic programme, on 27 November 1992, the Council of 
Ministers decided to grant to Romania a further medium-term loan in the amount of ECU 
80 million to assist the country in its economic reform process and to strengthen the reserve 
position of the central bank3. The assistance was made available in the context of an 
initiative by the Group of Twenty-Four aimed at providing a total of US$ 180 million in 
assistance complementary to that provided by the IMF under a stand-by arrangement 
approved in late May 1992. 
The Community loan was disbursed in one tranche in February 1993, following a positive 
assessment of progress in the field of economic stabilization and reform. 
2. Macro-economic performance in 1992 
The government maintained prudent fiscal and monetary policies and exercised wage 
restraint during most of 1992. Measures in all key areas showed the strong commitment of 
the government to the stabilization programme : the phased elimination of consumer 
subsidies began with an initial 25 percent reduction in May and continued with a further 25 
percent reduction in September; the refinancing rate of the National Bank of Romania was 
increased to 80 percent in May in an effort to ensure that interest rate is positive in real 
terms; and the exchange rate liberalization started on June 2, following the elimination of 
the 100 percent surrender requirement a month earlier. 
3 Decision 92/551/EEC, OJ n° L 353 of 3.12.92, p. 30 
-41-
In the fiscal area, in response to the significant erosion of the tax base during the year, 
nominal tax rates were raised and expenditures in the state budget and major social funds 
were restricted. Thus the consolidated deficit of these entities amounted to only 1 percent 
of GDP, well within the programme target. 
Macroeconomic developments in 1992, however, indicate that the result of the economic 
programme of the Government was mixed. The authorities had some success in bringing 
down inflation, but economic activity continued to be weak. Inflation came down 
dramatically to about 3 percent a month in July and August 1992, but following a new-
round of adjustments in the prices of subsidized consumer goods in September, it hovered 
around 10 percent a month by the end of the year. In 1992, aggregate output fell by some 
15 percent. The decline was especially marked in the industrial sector, where output fell by 
some 23 percent. Unemployment increased from 3 percent to 9 percent of the labour force. 
Private sector activity, however, increased rapidly, reflecting in large part the privatization 
of agriculture, and, to some extent, the incipient development of private activity in the 
service sector. By the year-end, it already accounted for some 28 percent of recorded GDP. 
The balance of payments was on track during the first semester of 1992. In the third 
quarter, the external current account improved significantly, registering a surplus of US$ 
100 million as export performance remained strong while imports declined sharply. In the 
final quarter of 1992, however, the current account deficit worsened sharply, and for the 
year as a whole, it amounted to some 8 percent of GDP. 
Official balance of payments support from the Community and other G-24 countries was 
expected to reach US$ 917 million in 1992, including the carry-over of the disbursement of 
US$ 737 million corresponding to the entire balance of payments assistance relating to 
1991. Most of the assistance relating to the 1991 exercise was disbursed in 1992. With 
regard to the balance-of-payments assistance package for 1992, corresponding to the 
identified financing gap of US$ 180 million, commitments only reached US$ 111 million 
(including ECU 80 million for the EC) and no disbursement was made in 1992. 
Consequently, the balance-of-payments target for the entire 1992 was not reached. 
3. Structural reform in 1992 
Significant progress was made in the implementation of the structural reform measures : 
prices were substantially liberalized, subsidies reduced, foreign trade was liberalized, an 
agency in charge of the privatization process was established, certificates of ownership 
were distributed, state enterprise arrears reduced and a foreign investment legislation 
introduced. 
In certain areas of reform, however, some slippages were recorded. The exchange rate was 
pegged to the dollar in the last quarter of 1992 at an unsustainable level in view of the 
prevailing inflation rate, resulting in the re-emergence of a parallel exchange market where 
the national currency sold at a discount of 20-25 percent. Importers' requests for foreign 
exchange were not fully met, and following the elimination of surrender requirements for 
exporters in June 1992 exporters built up their deposits in foreign currencies. The 
privatization process recorded delays, affecting both the quick privatization programme for 
small subunits and the pilot privatization programme for large enterprises. Delays were also 
recorded in the passage of adequate legislation regarding bankruptcy. 
4. Review of performance criteria attached to the EC financial assistance 
The Memorandum of Understanding between the Commission and Romania provided for 
an evaluation of progress made with respect to stabilization policies and structural 
adjustment policies. The quantified performance criteria were identical to those contained 
in the IMF stand-by arrangement approved in May 1992. The structural adjustment criteria 
were designed to evaluate progress made in the major fields of reform. 
The review of performance criteria was effected in December 1992. At that time, the IMF 
had completed its mid-term review. All quantitative macro-economic performance criteria 
for end-June and end-September were observed and the disbursement by the IMF of the 
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first three tranches of the stand-by credit had been effected. Net credit to the government 
had declined in the first nine months of 1992, as the fiscal position had moved into surplus 
in the third quarter. Net domestic assets had remained well below the programme ceiling. 
International reserves through September had increased in line with the programme through 
September despite delays in disbursements form official sources, owing to a significant 
improvement in the current account. 
The structural performance criteria included in the Memorandum of Understanding were 
reviewed by the Commission staff in cooperation with the authorities. The findings on 
these criteria, which are summarized below, suggested that these conditions were also 
broadly met. Based on this assessment, the Community loan was disbursed in February 
1993. 
4.1. Prices and subsidies 
On May 1 and September 1, 1992, the government had increased the price of the consumer 
products still subject to control, cutting by 50 percent the subsidies on these items. The 
government intended to eliminate the remaining subsidies in the first semester of 1993. 
With regard to energy prices, the government had maintained parity with world market 
prices for crude oil, electricity, coal and lignite, and it had increased the price of natural gas 
by 10 percent per quarter in real terms. 
4.2. Foreign trade 
All export quotas as well as licensing requirements for imports and exports had been 
eliminated, except for goods still subject to price control and subsidies, and few strategic 
items. 
4.3. Privatization 
The Private Ownership Funds and the State Ownership Funds had been established, and 
were developing their internal organization. The National Agency for Privatization had 
distributed Certificates of Ownership representing 28 percent of the bank value of the 
commercial companies (corresponding to 92 percent of the Certificates to be distributed). 
Out of 3000 units selected for early small privatizations, 1,214 had been sold by mid-
November, whereas the structural adjustment criteria called for the completion of the bulk 
of these privatizations by year end. In this area, where some delays had been experienced, 
the government committed itself to expediate the privatization process. 
With regard to the thirty companies selected for early pilot privatization, 8 were privatized 
and 18 other prepared for privatization, of which 6 were in advanced phases of 
negotiations. 
4.4. Enterprise financial discipline 
With regard to enterprise financial discipline, a new law to enforce enterprises financial 
discipline (Law 76) was enacted on July 16, 1992, followed by Government Decision n° 
701/1992 on the same purpose. The law established procedures by which creditors can sue 
debtors for overdue payments, and the actions they can take, like seizure of monetary and 
real assets, forced restructuring and liquidation, against defaulting enterprises. As a result 
of these measures, the state enterprises arrears declined form 25%» of state enterprises 
turnover in June to 15% in October. Furthermore, to reduce tax arrears, the government has 
raised the penalty rate on overdue tax payments to above the level of market interest rate. 
4.5. Investment 
With regard to investment, the Law providing for free repatriation of profits for foreign 
investors had been passed. 
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5. Developments in 1993 and prospects 
Macroeconomic developments in 1993 indicate that progress towards stabilization 
continued to be elusive. Inflation continued unabated with prices rising by approximately 
300 percent over the year. The official exchange rate depreciated sharply in nominal terms 
(from lei 430 per dollar in December 1992 to lei 1280 per dollar by end-1993); and the 
spread between the official rate and that of the parallel market remained substantial (in the 
order of 50 percent by year-end), while official reserves were depleted. However, the 
decline in economic activity seems to have bottomed out in 1993. 
The authorities brought to its final stage the process of price liberalization and elimination 
of consumer subsidies. They eliminated some consumer price controls and substantially 
adjusted the remainiig ones on May 1, 1993, while eliminating the corresponding 
subsidies. Moreover, controls on allowable commissions and markups were eliminated on 
July 1, 1993. Also, VAT was introduced on May 1, with a single rate of 18 percent, to 
replace the turnover tax. 
Despite those important and difficult measures, other actions in key areas that are necessary 
to overcome the experienced persistent difficulties in stabilizing the economy, had not yet 
been taken by December 1993. In particular, the pace of reform in state enterprises has 
remained inadequate, allowing to undermine macroeconomic policies and the credibility of 
the government's stabilization efforts. Also, the exchange rate regime needs to be 
liberalized, not to discourage much needed export-oriented investment. 
Owing to these policy shortcomings, Romania was not in a position to make the final 
purchase under the IMF stand-by arrangement before it expired in end-March 1993, and the 
negotiations on a new stand-by arrrangement with the IMF that started early in 1993 
dragged on during most of 1993. The G-24, at the Country Coordinating Meeting for 
Romania held in May 1993, impressed on the Romanian authorities the need to implement 
forcefully stabilization and reform measures; the G-24 recognized that this will be a 
particularly difficult task and that further assistance from the ^international community will 
be critical in the successful implementation of the measures. They however cautioned that 
new complementary macro-financial assistance by the G-24 will be considered in light of 
the commitment to reform by the Romanian government and in view of the outcome of the 
consultations underway between Romania and the Bretton Woods institutions. 
In December 1993, the authorities finally reached a new agreement in principle with the 
IMF, that should be, in principle, a major step towards stabilization and structural reform of 
Romania's economy. In this context, they requested further complementary financing from 
the EC/G-24 that will have to be considered in the beginning of 1994. 
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VI. ALBANIA 
1. Introduction 
In mid-1992, against a background of severe economic, social and administrative 
dislocation, and facing fiscal and external imbalances much larger than in other countries in 
the region, the government of Albania, backed by the strong political mandate in the 
elections in March, committed itself to the daunting task of implementing a comprehensive 
economic reform. The immediate priority of the Albanian authorities was to stabilize the 
economy and to initiate profound structural changes towards an open market economy. 
The government's programme was supported by the international financial institutions and 
the G-24. A twelve-month stand-by arrangement with the IMF covered the period mid-
1992 to mid-1993. In view of the need to restore official reserves and of the large 
commercial arrears that impeded access to private creditors, the programme was critically 
dependent on complementary external support from the G-24. At the High-Level meeting 
held in Tirana in July 1992, the G-24 responded positively to the Albanian request for 
complementary macro-financial assistance in the form of grants or highly concessional 
loans to fill the residual balance-of-payments gap of US$ 165 million. In the context of the 
G-24 initiative, the Community decided, on 28 September 1992, to grant Albania financial 
assistance of a maximum amount of ECU 70 million in the form of a grant, to be disbursed 
in two installments (Council Decision 92/482/EEC). Overall, the assistance committed by 
the G-24 under the 1992-93 programme has amounted to some 70 percent of the original 
gap, despite the fact that the assistance initially committed by some countries was 
eventually disbursed in the form of tied aid (which does not fall within the G-24 macro-
financial assistance scheme). 
The Community grant was disbursed in two tranches. A first trance of ECU 35 million was 
disbursed in December 1992; and, following a positive assessment of the economic 
situation and progress in the reform process in Albania, and a favourable opinion of the 
Monetary Committee, the disbursement of the second tranche was effected in August 1993. 
Macro-financial assistance from the Community and other G-24 countries has been 
instrumental in permitting the government of Albania to implement its ambitious economic 
programme. The foreign financial assistance was used primarily to strengthen the reserve 
position of the country, and allowed the authorities to rapidly liberalize the exchange 
market and to introduce a freely determined exchange rate within a unified exchange 
market. 
The first stage of economic stabilization and reform having been successfully achieved, the 
Albanian authorities have now shifted from a mainly short-term horizon, dictated by the 
crisis prevailing at the beginning of 1992, toward a consistent medium-term approach. To 
that effect, they have adopted a comprehensive medium-term economic programme for 
1993-96. This programme was presented to the G-24 High-Level meeting held in Brussels 
in November 1993. At that meeting, the G-24 recognized that Albania continues to face a 
very difficult external financial situation and that it will continue to need macro-financial 
assistance from the G-24, in the order of US$ 72 million, for the period mid-1993 - mid-
94, complementary to the ESAF arrangement agreed with the IMF in July. In that context, 
the Commission will, in due course, propose further financial assistance to Albania. 
2. Macro-economic performance in 1992-1993 
In view of the great difficulties and risks under which Albania embarked in its programme 
in mid 1992, achievements on the macroeconomic front have been considerable. The slide 
into hyperinflation has been reversed, and the downward spiral of output has been 
corrected. By 1993, government domestic financing requirement dropped (to 11 percent of 
GDP from 41 percent of GDP in the first half of 1992), while credit expansion was reduced 
sharply, well within the credit ceilings, and redirected in favour of the incipient private 
sector. Credit to non-performing public enterprises and state farms has been substantially 
curtailed since the beginning of 1993. In sharp contrast to the situation prevailing up to the 
-45-
end of 1992, state enterprise financial discipline has been enforced in 1993, and the sharp 
rise in inter-enterprise arrears which threatened the stabilization effort has been arrested, as 
the system of receivable orders has been abolished and the banks have been instructed not 
to accept any payment order not backed by sufficient funds. As a result of the tight 
budgetary and monetary policies, inflation was curbed (to a monthly rate of 2 percent~in 
1993). Reflecting the strong domestic effort as well as large external support, foreign 
reserves were built up as planned (amounting to some $ 80 million equivalent to 1 1/2 
months of imports at end-June 1993, and US$ 146 million by the year end) and the 
(floating) exchange rate remained fundamentally stable, hovering around leks 95-105 per 
US dollar. The fall in production has bottomed out since the end of 1992 (GDP is estimated 
to have grown by 11 percent in 1993), albeit from a very low base, thanks to the good 
performance of the private sector (in agriculture, services and construction), whereas state-
sector industrial output has continued to drop in 1993 owing to the imposition of financial 
discipline. 
The stabilization gains of recent months remain, however, fragile and tentative and Albania 
will have to continue to rely heavily on foreign assistance in the short run. Exports ($ 70 
million in 1992; $ 105 million in 1993) cover only a fraction of import needs ($524 million 
in 1992; $ 585 million in 1993). Furthermore, the external outlook remains clouded by 
Albania's large external debt, mainly with commercial banks ($ 834 million at end 1993, 
including accumulated arrears of $ 621 million), and Albania's very limited capacity to pay. 
Whether Albania is able to attain external viability in the medium term will depend 
critically on an early normalization of relations with commercial banks as well as with 
bilateral official creditors. 
3. Structural reform 
While making significant gains in macro-economic stabilization, Albania initiated in mid-
1992 profound structural changes towards a market economy. Critical measures under its 
programme for 1992-93 included major reforms of the price and exchange regimes, 
liberalization of trade and foreign investment, and the start of other structural changes 
focusing on agriculture, state enterprises and the financial sector. During this period, 
progress was made in imposing financial discipline on state-owned enterprises and 
privatizing agriculture and small scale services and industry. However, reforms have 
proceeded at a slower pace in the fields of privatization of medium and large sized 
industrial enterprises and foreign direct investment. A new momentum of structural 
reforms has been built up in the wake of the preparation of the comprehensive medium-
term economic programme for 1993-96 formulated in the Policy Framework Paper. 
Price reform has advanced rapidly during the past year and the budgetary cost of subsidies 
has therefore been contained. All wholesale and retail prices have been freed, with the 
exception "of wheat, bread, sugar beet and a number of non-food items produced under 
monopolistic conditions (energy, rents, medicines, telecommunications, urban transport 
etc). A new series of price rises was implemented in mid-1993, which included the 
doubling of the prices of wheat, flour and bread, a sensitive issue due to the importance of 
bread in the local diet and the dependence of the country on wheat imports. This constitutes 
a major additional step towards completing price reform in Albania, and should help 
stimulate the recovery of domestic wheat production, as well as promote the import, 
distribution and processing of wheat by the private sector. In an effort to cushion the social 
impact of this measure the government has designed a large compensation scheme, in the 
understanding that it will be phased out in the course of 1994. Other price rises initiated in 
mid-1993 include the twofold to threefold increase of public housing rents and household 
energy. 
Foreign trade has been liberalized, with export licensing only applying to products still 
subject to price controls and to a limited list of strategic products, or in order to prevent 
diversion of food assistance. The exchange rate is determined freely within a unified 
exchange market, the efficiency and depth of which has been improved by the licensing of 
foreign exchange dealers and exchange bureaus. 
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In agriculture, a key sector of the economy which accounts for half of the value added and 
employs around 60 per cent of the population, the upheaval associated with the dissolution 
of the former cooperative farms resulted in at least a 35% drop in output during the 1990-
91 season. Albania, formerly a net exporter of food became a recipient of food aid. The 
international community, with the EC as the principal donor, furnished 400,000 tons of 
food aid in 1991-92 and 450,000 tons in 1992-93. The privatization of agricultural land 
resulted in a 18%» rise of output in 1992 and a further substantial increase in 1993 (14%). 
Yet, despite the rapid growth of output, further shipments of food aid to Albania might be 
necessary, albeit in reduced quantities. 
About 80% of the land area has been privatized to date. Nearly all former co-operative 
farms, constituting about 75%» of arable land, have been successfully privatized. This has 
resulted in the creation of over 315,000 private farms. State farms, which occupy the 
remaining 25% of the land and are mostly situated in the fertile lands of the coastal plains, 
'are being privatized through leasing arrangements, or through the distribution of ownership 
rights to workers. The distribution of titles should be completed by the end of 1994. 
However, this strategy has led to the division of arable land into small, uneconomic plots, 
averaging 1 1/2 ha, and the majority of farmers operate on a subsistence basis. In an effort 
to facilitate the consolidation of the small holdings, the government is pushing for the rapid 
conclusion of the distribution of private ownership titles. The government plans to 
complete the legal framework concerning agricultural property, with rights to sell, lease 
and mortgage the land, thus leading to the creation of a land market. 
The reform of the public enterprise sector poses one of the greatest challenges to Albania's 
economic programme. Clearly, large sections of industry are no longer viable and most 
enterprises will find it difficult to operate now that budgetary support has been depleted 
and they are forced to operate on commercial terms, as the capital stock is obsolete, the 
domestic market is small and impoverished and there is no tradition and experience of 
export-oriented production and marketing. Furthermore, the administrative capacity to 
carry out a large scale restructuring is limited. 
At first, in 1992, reform was mostly confined to the privatization through direct sales to 
employees of the small units operating in the handicraft, transport and services sectors. The 
authorities had difficulties to maintain financial discipline on the remaining public 
enterprise sectors. The sharp increase of inter-enterprise arrears in 1992 undermined the 
survival of enterprises and posed a major threat to the stabilization policy. Since the 
beginning of 1993, however, the government has stopped the flow of new arrears by 
issuing appropriate instructions involving both enterprises and banks. 
Privatization in the enterprise sector also has been delayed by the difficulty to establish a 
restitution policy. The passage of a law on the restitution or compensation for urban 
properties to previous owners on 15 April 1993, and a law for the compensation to former 
owners of agricultural land on 22 April 1993, followed by the administrative arrangements 
to implement these laws (including the setting of firm deadlines for the presentation of 
claims), have paved the way for the rapid implementation of a privatization strategy, to 
complement those operated in 1992. 
The government is currently developing a multi-track approach that involves rapid 
privatization of small- and medium-sized industrial enterprises as well as longer-term 
procedures for large, more problematic enterprises. 
The government is proceeding with the estimated 1200-1500 small and medium-size 
enterprises (up to 300 employees) quickly, without allowing fiscal revenue considerations 
to slow the process significantly. To that effect, the Council of Ministers has issued a 
decree on 1 June, that provided for the privatization of those enterprises through auction. 
These auctions will be effected with a decentralized procedure at the level of the district by 
local councils. Some 300 enterprises have already been identified for this immediate 
privatization. 
With regard to the 300 larger enterprises, the government is finalizing a strategy involving 
rapid privatization or liquidation for most enterprises. A small group of "strategic" firms 
will be sold by tender. Budgetary support will be minimized, focussing mainly on about 30 
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"problem" enterprises. To deal with those, the government has established, with the support 
of the World Bank, an Enterprise Restructuring Agency (ERA) placed under the authority 
of the Council of Ministers. The ERA is to formulate targets regarding privatization, 
liquidation or restructuring for all enterprises under its control in order~to bring these 
enterprises into operating balance within 1-2 years. A fixed budgetary envelope is 
available to finance these reforms. 
Control over the remaining state-owned enterprises will be established through the creation 
of a financial monitoring system and the appointment of outside directors. A tight budget 
constraint will be maintained for all enterprises, with bank credit available only on 
commercial terms and safeguards against the accumulation of arrears. 
With regard to the financial sector, a two-tier banking system was created in Albania in 
early 1992, when the central and commercial banking activities were separated and 
respectively transferred to the new Bank of Albania and to four state-owned commercial 
banks. The resulting commercial banking sector is characterized by a high degree of 
monopolistic segmentation and is burdened by the existence of a large portfolio of non-
performing loans. 
The government is in the process of dealing with the problem of non-performing loans by 
replacing net enterprise debts to banks by government bonds. Further restructuring of the 
banking system is envisaged. 
The legal framework of a market economy is currently being put into place. The Parliament 
has approved a Company Law, a Banking Law, a Central Banking Law, a Bankruptcy Law, 
an Accounting Law, as well as labour legislation. The first part of the revised Commercial 
Code has been adopted while a new Anti-Trust law and a Civil Code still have to be 
completed. 
In view of the very weak enterprise sector and the extremely limited outside contacts that 
Albania had before 1991, it has a particular need for foreign investment. Yet the existing 
legislation did not provide' sufficient guarantees to ensure foreign participation in the 
privatization process while the law on -land ownership does not allow foreigners to own 
land in Albania (though they may lease it for 99 years). Amendments to the 1992 Foreign 
Investment Law, which will eliminate separate authorization requirements for foreign 
investment and will allow foreigners to participate in privatization of state assets, were 
passed in late 1993. 
4. Review of performance criteria attached to the EC financial assistance 
The memorandum of Understanding between the Commission and Albania, signed on 10 
December* 1992, provided for an evaluation of progress made with respect to stabilization 
and structural adjustment policies. The quantified performance criteria were identical to 
those contained in the IMF stand-by arrangement and included the following elements : 
quarterly limits on overall credit and on credit to the government, quarterly minima for 
international reserves, and limits on external payments arrears and on the contracting of 
new external debt by the public sector. 
The structural adjustment criteria were designed to evaluate progress made in the field of 
price, trade and exchange liberalization, the establishment of a legal framework for private 
activity and the privatization of enterprises. The successful review of progress in economic 
stabilization and reform, including the compliance with performance criteria, was a 
condition for the release of the second tranche of the grant. 
The review of IMF conditionality, completed in March 1993, concluded that the 
quantitative performance criteria were met and the reform programme remained on track, 
so that no adjustments to the programme were required. In the face of the shortfall in 
external assistance, it means that domestic policy restraint by Albania was stricter than 
envisaged in the programme to preserve the targeted external position. The structural 
performance criteria were also largely met. Price reform advanced rapidly. Foreign trade 
was liberalized and the exchange rate has been determined freely within a unified exchange 
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market. Major elements of the legal framework of a market economy have been put in 
place. Privatization of agriculture and of small enterprises in the services sector progressed 
rapidly. 
With all criteria attached to the Community loan broadly met, the second tranche of the 
Community grant was disbursed in August 1993. 
5. Assessment and prospects 
The Government of Albania now aims to sustain the momentum of stabilization process, 
promote growth and progress toward external viability. To that end, it has formulated a 
comprehensive medium-term economic strategy for 1993-96 and designed a detailed 
programme for the first year under this framework (mid-1993 to mid-1994). 
The principal macro-economic objectives of the programme for 1993/94 are : a real growth 
.of 3-4 percent; a reduction of the 12-month rate of inflation to 33 percent by mid-1994, and 
a further strengthening of the external position, including a build-up of official reserves to 
3 months of imports by mid-1994. The adjustment strategy will remain centered on tight 
demand policies, supported by adequate external support and an early solution of the 
arrears problem. 
In order to reduce macro-economic imbalances, fiscal adjustment remains a central element 
of the programme, together with the continuation of tight monetary and state-sector 
incomes policies. In view of the expected decline of food aid counterpart revenues and the 
need to attend to a number of critical expenditure needs (including investment and 
structural reforms) that can no longer be deferred, the commitment to reduce the domestic 
financing of the budget to 7 percent of GDP will constitute a major challenge. In support of 
the Albanian programme, the IMF approved in July 1993 an arrangement under the 
Enhanced Structural Adjustment Facility (ESAF), and the authorities have requested 
complementary assistance from the EC/G-24 of $ 72 million for the first year of the 
programme. 
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Vn. THE BALTIC STATES 
1. Introduction 
Following the Soviet annexation of Estonia, Latvia and Lithuania in 1940, their economies 
underwent a rapid industrialization as a result of massive capital formation and labour 
movements (both from agriculture into industry and from other parts of the Soviet Union 
into Estonia, Latvia and Lithuania). They nevertheless kept a strong competitive position in 
agricultural production and provided other (former) Soviet republics with meat, dairy and 
fish products, which had been formerly exported to the West. Given their higher economic 
efficiency stemming from a skilled work force and a comparatively well-developea 
infrastructure, the countries' per capita income was significantly above the Union average. 
However, it was increasingly felt that the Soviet central planning system restricted the 
potential of the economies. In November 1989, Estonia Latvia and Lithuania succeeded in 
obtaining the adoption of the Law on Economic Independence by the Supreme Soviet of 
the USSR, which opened the way for the initiation of economic reforms in a number of 
areas, including price and wage determination, fiscal policy, and financial sector policies. 
By the time the Baltic States formally regained their independence from the (former) 
Soviet Union, in August 1991, they had already made the first steps to reform their 
economies and disentangle them from the highly integrated Soviet economic structure, 
which had provided over 90% of their imports, through their re-orientation towards 
Western markets. When in 1992 the three countries had to pay imports from Russia at 
world market prices, compared to the earlier heavily subsidized rates, they suffered a 
severe terms of trade shock. 
After the Baltic States had become members of the International Monetary Fund (IMF) in 
Spring 1991, they finalized, in close cooperation with the IMF their stabilization and 
reform programmes, covering the period from mid-1992 to mid-1993. In support of these 
programmes, the authorities of the three countries requested complementary macro-
financial assistance from the EC/G-24 to cover the residual financial gaps estimated at US$ 
105 million for Estonia, US$ 210 million for Latvia and US$ 285 million for Lithuania. 
Following positive indications made by a number of G-24 countries towards the 
participation in the support scheme, the IMF Board approved the Latvian stand-by 
arrangement on 14 September 1992, the Estonian arrangement on 16 September 1992 and 
the Lithuanian arrangement on 21 October 1992. 
In November 1992, the EC Council decided (Council Decision 92/542/EC of 23.11.1992) 
to provide the Baltic States with a loan of up to 220 mecu (40 mecu for Estonia, 80 mecu 
for Latvia and 100 mecu for Lithuania), which corresponded to roughly half of the balance 
of payments gaps estimated by the IMF, in order to address the general balance of 
payments needs of these countries; this contribution was nearly matched by financial 
assistance from the EFTA countries and Japan. The EC loan agreements and memoranda 
of understanding were signed with Estonia and Latvia on 8 January 1993 and with 
Lithuania on 1 March 1993. The Commission disbursed the first tranches of the loans to 
Estonia and Latvia on 31 March 1993 and to Lithuania on 27 July 1993. The release of the 
second tranches was made conditional on a successful review of progress in the area of 
economic stabilization and reform, including the observance of a number of performance 
criteria agreed by the respective parties. Following a positive review and the conclusion of 
a supplementary agreement regarding the absorption of the assistance in October, the 
Commission is expected to disburse the second tranche to Estonia in Spring 1994. 
Following similar reviews and subject to analogous agreements, the disbursements of the 
remaining tranches for Latvia and Lithuania are expected for the same period. 
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2. Estonia 
2.1. Economic reforms from mid-1992 to mid-1993 
2.1.1. Background 
In the course of 1990 and 1991, the prices of a number of goods were either liberalized or 
administratively raised and subsidies on energy, telecommunications and transport were 
reduced. After the adoption of the Law on Enterprises in 1989, the number of Estonian 
companies with less than 100 employees increased from 34 to over 20,000 at the end of 
1991. Following the passage of the Law on Privatization of State-Owned Trade and Service 
Facilities in 1991, the privatization of smaller enterprises progressed substantially. Reform 
of large-scale enterprises had a slow start. Following initial financial sector reforms 
undertaken by the Soviet authorities in 1988 with the objective to establish a two-tier 
banking system, the nationalization of the Estonian financial system began. In 1990, the 
Estonian authorities recreated the Bank of Estonia, but it was not until 1 January 1992 that 
the regional branch of the Gosbank could be liquidated and incorporated into the Bank of 
Estonia. By early 1992, there were 40 licensed commercial banks, in addition to four state-
owned banks. After Estonia gained independence from the (former) Soviet Union, trade 
with this area, and in particular with Russia, collapsed. In order to stem this development, 
Estonia concluded a number of bilateral agreements with former Soviet republics hoping to 
secure the resumption of imports, in particular of energy from Russia. This was only partly 
successful. Trade with Western countries grew rapidly, albeit from a low level. This was 
made possible by Estonia's fairly liberal trade regime. Since early 1991, the Estonian 
Government has adjusted the budget process and the tax system to the needs of a market 
economy. 
Following a deterioration of the Estonian economy in the 1980s in line with the gradual 
breakdown of the Soviet planning system, output dropped sharply in 1991 (-11%, after -4% 
in 1990) due to trade disruption with other Soviet republics. Unemployment remained very 
low during this time (less than 1%). Given the liquidity overhang, price liberalization led 
to high inflation. 
2.1.2. Objectives and features of the Government's reform programme starting mid-1992 
The two main objectives of the Government's economic programme for mid-1992 to mid-
1993 were macroeconomic stabilization and structural reform. With regard to stabilization, 
the main features were the completion of price liberalization, restrictive fiscal policies, 
monetary discipline under the currency board system, strict incomes policy and further 
liberalization of the exchange and trade system. With respect to structural reform, the 
programme comprised an acceleration of the privatization process, completion of the 
restitution "process, financial sector reform, improvement of the social safety net, 
restructuring or closure of nonviable enterprises and banks and the establishment of a legal 
framework in support of a market economy. The programme targeted a fall in output of 
15% for the programme period and a deceleration of the annual rate of inflation to 6% by 
the end of the programme period. 
2.1.3. Price liberalization 
By mid-1992 most price controls had been dismantled, leaving only some prices under 
regulation which were charged by certain state-owned enterprises considered to be of 
special importance; goods and services produced in the private sector were not subject to 
any controls. Further progress was made in the second half of 1992. The Government 
removed the authority of municipalities to regulate the prices of state enterprises operating 
in their locality. In addition, a number of items including bread, flour, grains and sugar 
were removed from price control. Finally, the adjustment of energy prices to world market 
levels was continued with further increases in the prices of natural gas and fuel oil. By the 
end of 1992, the price liberalization process had been essentially completed. 
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2.1.4. Enterprise reform 
Privatization of small firms has continued to progress. By mid-1993, the share of small 
enterprises privatized had exceeded 50%. Privatization of medium- and large scale 
entreprises, however, has turned out to be more difficult than envisaged. Problems included 
disagreements regarding the privatization mechanisms and unresolved restitution issues 
(The Government is committed to restitute or compensate all owners of property in Estonia 
prior to 1940, or their descendants). One obstacle to progress in privatization was finally 
removed when the Government set the final deadline of 1 April 1993 for the receipts of any 
restitution claims. In August 1992, the Government passed a comprehensive bill that 
established mechanisms for the sale of enterprises worth more than EEK 600,000. At the 
same time, the Estonian Privatization Office (EPO) was established to organize the 
privatization process. From the initial list of 38 enterprises offered for sale in late 1992, 25 
were privatized. By mid-1993, another 52 enterprises had been offered for .privatization. 
The proceeds of the sales are allocated between a compensation fund for restitution claims, 
the state budget and the Bank of Estonia. The authorities have also made efforts to 
improve the performance of those enterprises remaining under state control. Pressure to 
restructure resulted from hard budget constraints which were in part maintained by 
applying the Bankruptcy law passed in September 1992. 
21.5. Financial sector and currency reform 
The Bank of Estonia, which had been reintroduced in 1990, is responsible for monetary 
policy, managing the payments system and for banking supervision. Until mid-1992, it also 
undertook some commercial activities inherited from the merger with the former branches 
of Gosbank and the Vnesheconombank. 
Since its independence from the (former) Soviet Union in August 1991, Estonia was faced 
with a shortage of cash roubles, which had been traditionally supplied by Gosbank in 
Moscow. This led to the disruption of certain kinds of payments and the limitation of 
access to bank deposits by the public. The Estonian authorities implemented a currency 
reform on 20 June 1992 which put an end to Estonia's membership in the rouble zone (it 
was the first republic to leave it). The reform included the reintroduction of the Estonian 
kroon (EEK) as national currency under a currency board system providing 100% reserve 
backing for all money issued. The exchange rate of the kroon was legally fixed at 8 EEK = 
1 DM. The kroon was rapidly accepted as the only legal tender and international reserves 
held at the Bank of Estonia increased following the reform. 
In the period immediately after the currency reform, strains in the banking system became 
evident. They were generally characterized by delays in clients' access to deposits with 
commercial banks, ranging from a few days to several weeks. As these were symptoms of 
liquidity problems, in particular with three large banks, it was decided in early 1993 to 
recapitalize and merge two of them and take the merged bank under Government control, 
and to liquidate the third one. This helped restore normalcy to the banking system. At the 
same time, the Bank raised the minimum capital requirement from EEK 500,000 to EEK 6 
million, which contributed to the decline of the number of commercial banks licensed in 
Estonia from 40 to 24 by mid-1993. 
216. External sector policies 
By March 1992, Estonia had abolished nearly all import tariffs that had existed under the 
Soviet system, leaving Estonian trade entirely tariff free except for a few items (import 
tariffs on alcohol, tobacco, furs, automobiles; export tariffs on art works, rapeseed oil and 
metals) and a 0.5% administrative fee on imports. Since November 1992, imports have 
been also subject to a 18%» VAT. In parallel with the general removal of tariffs, the 
remaining quotas and licensing requirements for imports had also been abolished to a large 
extent. On 1 January 1993, the list of goods was further shortened (eliminating e.g. alcohol, 
tobacco, grain, hide, ferrous and non-ferrous metals) so that it covered only oil shale, clay 
and quartz. In February 1993, the Government"took trade of non-ferrous metals under its 
direct control (state monopoly) in order to eliminate illegal re-exports. As a whole, 
Estonia's trade and foreign investment regime can be considered as liberal. 
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Except for the trade agreement concluded with Russia in February 1992, which foresaw 
trade volumes guaranteed by both Governments, agreements concluded with most other 
former Soviet republics between December 1991 and July 1992 foresaw direct trading 
between enterprises. In general, the agreements did not fulfil their objective in overcoming 
the severe trade disruptions with former trading partners, in particular Russia. In contrast, 
trade agreements with Finland, Sweden and Norway (free trade except for agriculture) and 
with the EC certainly contributed to a dynamic development of trade with this area. 
Since the currency reform, the Bank of Estonia guarantees the convertibility of the kroon 
for valid currency account transactions in unlimited quantities and at 8 EEK per 1 DM. 
Foreign currency accounts of resident individuals and enterprises with domestic banks were 
allowed to be kept after the currency reform, but balances could not be increased. In 
January 1993, the Foreign Currency Law was approved according to which the Bank of 
.Estonia could issue licences to enterprises involved in exports or imports to keep a working 
capital in accounts opened abroad. As a general rule there was a requirement to surrender 
100% of export proceeds to any commercial banks in Estonia. Capital account transactions 
must receive approval of the Bank of Estonia. However, this does not apply to the 
repatriation of capital by foreign investors. 
2.2. Macro-economic developments 
2.2.1. Production and employment 
From mid-1992 to mid-1993, Estonia's GDP declined by an estimated 18%. This reflects in 
particular the terms of trade shock suffered by Estonia following Russia's move to world 
market prices for energy products since early 1992 and general trade disruptions with the 
(former) Soviet Union. In addition, it signals the breakdown of the production of certain 
goods that are no longer competitive after being exposed to international competition. 
Finally, agricultural production suffered from the drought of Summer 1992. By mid-1993, 
the economic situation had broadly stabilized, and there were first indications that 
industrial production was increasing. 
Compared to the sharp output decline experienced in Estonia between 1990 and 1992, 
unemployment remained low until mid-1992. However, during the following 12-month 
period it rose to some 4% of the labour force. In addition, there is increasing evidence of 
temporary lay-offs, unpaid leave and a reduction in working days. 
2-2.2. Inflation and wage developments 
In mid-1992, the year-on-year increase in consumer prices had reached 1080%. This was 
above all the consequence of the liberalization of prices and the rise of import prices. These 
factors continued to play a role until the end of 1992, but during the first half of 1993 
inflation dropped sharply to reach 2-3% a month by mid-1993. Apart from the virtual 
completion of price liberalization, this successful move towards stabilization is due to the 
tight monetary policy implied by the currency board system and the firm incomes policy 
implemented by the Government since September 1992. Wage increases were broadly in 
line with price developments during the programme period, following a decline of real 
wages by about 45% in the first half of 1992. 
2.2.3. Public finances 
Wfaereas Estonia was not permitted under the Soviet system to borrow in order to finance 
deficits, such a rule did not apply after independence. Nevertheless, the Government tightly 
controlled expenditures and improved its revenues through a number of tax revisions after 
independence that the general budget was in surplus in 1991 and, owing to emergency 
measures, also in the first half of 1992. This fiscal stance was broadly maintained in the 
course of the following 12-month period with the support of revenue enhancing tax 
measures accompanying the currency reform, the removal of subsidies and a reduction in 
tax arrears linked to the implementation of the Bankruptcy Law. In the second half of 1992, 
the budget surplus stood at 1.5% of GDP and in the first half of 1993 at 1% of GDP. 
However, if the Government use of foreign loans in the first half of 1993 is taken into 
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account, the Government general borrowing requirement stood at 2.2% of GDP during this 
period. These loans were used to finance critical imports and to lend funds to the non-
Government sector in order to support investment in energy and infrastructure. 
2.2.4. Internal monetary conditions 
Before Estonia left the rouble zone in June 1992, its scope for independent monetary policy 
was strictly limited. Because of the adoption of the currency board system, this is still 
broadly the case after the monetary reform, but now Estonia is effectively insulated from 
the effects of Russian monetary policy. The link to the D-Mark and the currency board 
system have strengthened the confidence in the kroon. 
Credit policy, which had already been tight in the first half of 1992, tightened further 
following the monetary reform. Despite an inflow of foreign exchange, the banks 
increasingly refrained from extending credits as they became aware of the risks involved 
when the authorities lowered or stopped altogether the subsidization of ailing enterprises 
and given that real estate or other assets could not be legally accepted as collateral. As a 
consequence, loans were extended almost exclusively on a short-term basis, generally for 
trade deals. 
The real money stock continued to fall in the second half of 1992, and it was not until the 
second quarter of 1993 that broad money rebounded both in nominal and, to a lesser extent, 
in real terms. The composition of broad money changed dramatically after mid-1992, as the 
awareness about the risk of banks increased with the development of the banking crisis. As 
a consequence, the share of currency holdings rose from 7.4% in mid-1992 to 26.5% by 
year-end. 
Interest rates, which were in the rage of 80-100% for loans (20-40% for deposits) in mid-
1992, rose after the currency reform, and with the intensification of the banking crisis. But 
once the crisis was resolved, rates fell to 25-30% in mid-1993. Since this development was 
accompanied by a rapid deceleration of inflation, real interest rates which had previously 
been negative became positive during this period. 
2.2.5. External developments 
For the period 1 July 1992 - 30 June 1993, the Estonian current account showed a surplus 
of US$ 61 mio (4.3% of GDP) compared to the deficit of US$ 213 mio previously 
forecasted by the IMF. This was to a large extent due to a better than expected performance 
of exports and non-factor services. The expansion of imports may also have been limited to 
some extent by delays in the disbursement of foreign loans. 
After the collapse of trade with the former Soviet Union in the first half of 1992, trade 
volumes with this area remained low (42% of 1990 import levels, 34% of 1990 export 
levels). At the same time, trade with Western countries expanded dynamically so that 
exports to the West constituted nearly two thirds of Estonian exports in the first half of 
1993, compared to less than 10% before Estonia's independence from the Soviet Union. 
This reorientation of trade is the natural consequence of Estonia's exposure to international 
competition. 
Estonia's external debt stood at about 6.5% of GDP or some US$ 86 mio in mid-1993. 
Thanks to its liberal foreign investment policy and the credibility of its currency regime, 
Estonia benefited from foreign direct investment of US$ 102 mio between mid-1992 and 
mid-1993, which is substantially higher than expected. By mid-1993, the Bank of Estonia's 
gross international reserve holdings stood at US$ 275 mio (which equals 4.3 months of 
imports), compared to US$ 62 mio a year earlier. Net international reserves increased by 
US$ 224 mio, which is substantially higher than expected under the original IMF 
programme (US$ 91 mio). 
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2.3. Review of the performance criteria attached to the EC loan 
The Memorandum of Understanding agreed between the Commission and Estonia, after 
consultation of the Monetary Committee, provided for a regular evaluation of progress 
made with respect to stabilization and structural adjustment policies. The quantified 
macro-economic performance criteria were identical to those contained in the IMF stand-by 
arrangement and the structural adjustment criteria were designed to evaluate progress made 
in the area of enterprise reform, including privatization, banking sector reform, foreign 
trade and foreign direct investment. A favourable review of progress in economic 
stabilization and reform, including the observance of performance criteria was a condition 
for the release the second tranche of the loan. 
The reviews of IMF conditionality concluded that the stabilization programme was 
successfully implemented and that the performance criteria were met to the satisfaction of 
the IMF Board. An EC mission to Estonia in September 1993 concluded that the structural 
adjustment criteria attached to the EC loan were also broadly met: small scale privatization 
continued to progress; obstacles related to restitution were removed and new initiatives 
were taken and further measures are foreseen to speed up the privatization process; the 
generally liberal trade and foreign investment policy has been maintained and investment 
protection agreements have been concluded with EC members or will be concluded soon; 
efforts were made to restructure the banking sector and thereby to address the banking 
crisis. In a Supplemental Memorandum of Understanding concluded between Estonia and 
the Commission, the Estonian authorities agreed that they will pay special attention to the 
banking system, continue its restructuring and improve its capacity to perform normal 
credit operations and thus also channel appropriately to the domestic economy external 
macro-financial assistance. In order to limit the Government's intervention in the 
allocation process, it was also agreed that in principle the full amount of the second tranche 
of the EC balance of payments assistance would be channelled through the banking system. 
With all criteria attached to the Community loan broadly met and the Supplemental 
Memorandum of Understanding signed, the second tranche of the EC medium-term loan is 
expected to be disbursed in Spring 1994. 
2.4. Recent developments and prospects 
In the second half of 1993, the decline in output seems to have stopped and industrial 
production has begun to recover. Unemployment continued to rise only slowly, as 
enterprises were reluctant to implement redundancies because this would force them to pay 
up to eight months' severance pay. Inflation, which was reduced dramatically during the 
first half of 1993 to a monthly rate of 2-3%», did not continue to fall in the second half of 
the year. With the pick up of the economy, import growth seems to have strengthened 
further so that it is not likely that the current account has remained in surplus in the second 
half of 1993. 
Estonia has been receiving external financial assistance during the second half of 1993 and 
in 1994, including from the G-24 countries (the remaining US$ 56 mio not yet disbursed 
by mid-1993) and the World Bank. In September, it purchased the remaining three 
tranches (some US$ 20 mio) under the first IMF stand-by arrangement. Estonia concluded 
a second arrangement with the IMF covering the period mid-1993 to end-1994 (a 
combination of stand-by and systemic transformation facility). This will give the country 
access to purchases from the Fund in the order of US$ 40 mio over that 18-month period. 
This arrangement supports the authorities' comprehensive programme that aims at 
continuing the transformation of the Estonian economy while maintaining macroeconomic 
stability. Emphasis will be put on increasing investment in infrastructure, implementing 
structural policies aimed at strengthening the financial and entreprise sectors, and 
improving the effectiveness of markets, in particular the labour market. At the same time, 
the authorities will aim at maintaining fiscal prudence and the currency board. 
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3. Latvia 
3.1. Economic reform from mid-1992 to mid-1993 
3.1.1. Background 
In 1991, the Latvian authorities initiated comprehensive price reforms which involved 
administrative price adjustments combined with the liberalization of an increasing share of 
commodities in the consumer basket. Associated with these reforms was a reduction in 
subsidies from 13.7% of GDP in 1990 to 1.3% in 1991. The Latvian authorities also 
introduced a number of measures to nationalize and reform the financial system. The Bank 
of Latvia took over the activities of the previously nationalized Gosbank and four other 
state-owned banks (Industrial, Agriculture and Social Banks, which had been created under 
the Soviet reforms of early 1988 and the Foreign Trade Bank). This left the Bank of Latvia 
not only with central bank activities, but also with commercial activities and assets 
amounting to 65% of total assets of the banking system. In addition, thirty commercial 
banks were created between 1988 and early 1992, although some of them were relatively 
small. In June 1992, Parliament adopted legislation that allowed the Bank of Latvia to 
separate its commercial banking functions by end-1992. There were also first efforts with 
respect to enterprise reform and in particular privatization. A Law on Privatization of Small 
Municipal Enterprises was enacted in November 1991 and amended in 1992. The Latvian 
programme for ownership comprises three stages: municipalization, denationalization (or 
restitution), and privatization. By mid-1992, the first stage was largely completed, but 
progress with the other two stages was hampered by unresolved problems concerning 
citizenship, restitution and the lack of a coherent legal and institutional framework. 
Nevertheless, the private sector grew quite rapidly, in particular in the area of trade and 
services, as new small enterprises were established or privatized by municipalities. 
3.1.2. Objectives and features of the Government's reform programme starting mid-1992 
The two objectives of the Government's economic programme for mid-1992 to mid-1993 
were macroeconomic stabilization and structural reform. The main elements of the 
programme were the continued liberalization of prices and of the foreign exchange and 
trade system, as well as a number of systemic changes, including an acceleration of the 
privatization process. The measures were to be supported by restrictive fiscal, monetary, 
and incomes policies, which were considered crucial for creating a stable environment for 
the successful departure from the rouble zone and subsequent replacement of the interim 
currency. The programme targeted an output decline of some 18% and a monthly inflation 
rate of 1 1 /2% by June 1993. 
3.1.3. Price reform 
In July 1992, the Latvian authorities progressed further with price liberalization. The 
restrictions on profit margins for processors of agricultural products were removed and 
guaranteed minimum prices for agricultural products (except for grain) were abolished. At 
the same time, price restrictions were lifted for fuel oil, liquid gas and coal for industrial 
purposes (but maintained for household supply), as well as for international tourism and 
non-rail cargo transport. As a consequence of these measures, the weight of regulated 
goods and services prices in the consumer price index dropped below 8%. In October 1992, 
prices for alcohol were also liberalized. By end-1992, the price liberalization process was 
virtually completed. Included in the small number of items remaining subject to price 
control were utility prices and rents, which were adjusted upwards in Fall 1992 as a 
reaction to the large increase in the costs of imported energy. 
3.1.4. Enterprise reform 
From mid-1992 to mid-1993, Latvia made substantial progress in small-scale privatization 
for which the municipalities were responsible. However, large-scale privatization barely 
advanced during this period despite the fact that some 700 enterprises had been identified 
for privatization in 1993. Apart from unresolved restitution problems (in particular, long 
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deadlines for claims and unclear compensation alternatives), the process was hampered by 
the lack of a centralized and coherent privatization strategy and institutional set-up. In 
particular, line ministries were responsible for submitting privatization proposals that 
would entail a loss of control on these enterprises. The enterprises which were not likely to 
be privatized in the near future were transformed into joint stock companies. Only one 
enterprise had been liquidated by late 1993, which seems to be due to the complexity of the 
bankruptcy law of November 1991 on the one hand and to the fear to destroy a large 
number of enterprises interrelated by interenterprise debts on the other hand. 
3.1.5. Financial sector and currency reform 
On 20 July 1992, the Latvian authorities decided to replace the remaining Russian roubles 
in circulation by Latvian roubles, following the partial introduction of Latvian roubles in 
May 1992 when a severe shortage of cash roubles developed.The reform in July was 
speeded up by the inflow of roubles related to Estonia's departure from the rouble zone in 
June, and it was the starting point of a new, tight monetary policy. However, it is only with 
the introduction of the lats started in Summer 1993 that a permanent currency (the lats) was 
introduced. 
Following the adoption of the Law on the Bank of Latvia in May 1992, the Bank of Latvia 
issued instructions which made its commercial branches subject to all the stipulations 
applying to commercial banks under the Law on Banks and granted them a high degree of 
operational independence. At the beginning of 1993, a Privatization Commission appointed 
by the Parliament took over the 49 branches from the Bank of Latvia. Subsequently, 21 
were consolidated into a core bank (Universal Bank) which will be rehabilitated and 
privatized, and all other branches were privatized, except for one which was liquidated. 
The Bank of Latvia also decided to increase the capital adequacy requirement from the 
current 25,000 lats to 100,000 lats (about US$ 165,000) from January 1994 with a view to 
strengthening the banking sector. Furthermore, steps have been taken to strengthen banking 
supervision. In particular, new regulatory standards and formats of accounts complying 
with EC directives have been established. The liquidation of the first two banks was not 
realized until Fall 1993. 
3.1.6 External sector policies 
Latvia has a fairly liberal trade system. In June 1992, all export quotas and licensing were 
abolished and replaced by a system of export taxes. The Government also decided to 
abolish the export duties on most products with effect from 1 September 1993. There are 
no licensing requirements for imports. But new import duties have been levied since mid-
1992 on selected consumption goods. The Tariff Council established in May 1992 by the 
Government to periodically review tariffs and trade taxes nas decided in a number of cases 
to increase-specific import tariffs in order to protect local producers, in particular in 
agriculture. This has greatly complicated the Latvian import tariff structure. However, an 
Interim Customs Tariff Law submitted to Parliament is expected to partly correct the 
situation. The proposal does not only foresee a substantial reduction of previously 
increased particular tariffs, but also the introduction of (moderate) tariffs for raw materials, 
including energy. 
Latvia's foreign investment law allows free repatriation of capital and transfer of shares in 
the event of liquidation. Residents and enterprises are allowed to hold foreign currencies in 
cash, in domestic bank accounts or abroad. Enterprises can conduct their exchange 
transactions either through their banks or with private exchange dealers. Neither the 
Government nor the Bank of Latvia interfere in the allocation of foreign exchange. The 
Bank of Latvia ensures the smooth functioning of the foreign exchange market. 
3.2. Macro-economic developments 
3.2.1 Production and employment 
Latvia's economic activity suffered greatly from the terms of trade shock it faced in early 
1992 as a result of Russia's decision to liberalize its prices and to bill its exports to Latvia 
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in hard currency and at (near) market prices. The output decline was further compounded 
by trade disruptions with the former Soviet Union, resulting in a GDP decline of 34% in 
1992 (following a fall of 8% in 1991). But in the first half of 1993, the output contraction 
decelerated. Latvia's official unemployment rate increased to some 5% of the labour force 
in mid-1993, and increasing numbers of employees accepted a reduction in working time or 
salary. 
3.2.2. Inflation and wage developments 
After the near completion of price liberalization at the end of 1992, inflation also 
decelerated rapidly. By mid-1993, the year-on-year consumer price increase had been 
reduced to 152%. from 959% observed at the end of 1992. By that time, the monthly 
inflation rate had declined to about 1/2%. This dramatic decline was made possible by the 
tight monetary policy conducted by the Bank of Latvia since the currency reform of July 
1992, complemented by a broadly balanced general government budget and a tax-based 
incomes policy. 
Wage increases, continued to fall short of inflation in the second half of 1992. In the 
budgetary state sector this was achieved by the Government's decision in June 1992 to keep 
the minimum wage unchanged at LVR 1500, based on which all salaries were calculated, 
and a monthly taxable flat allowance of LVR 400 was granted. This allowance was 
increased in October and November to compensate for price increases. For non-budgetary 
state enterprises, the authorities adopted a tax-based incomes policy under which excessive 
wage increases were taxed at high and steeply progressive rates. With this policy, which 
lasted until mid-1993, real wages in the first half of 1993 were 8.5% lower than a year 
earlier (following 14% and 16% declines in 1991 and 1992, respectively). 
3.2.3. Public finances 
The Latvian Government managed to control budget expenditures and improve revenues so 
that the general government deficit for 1992 was kept- below 1% (including the 
Government's net lending activity in the order of 0.8% of GDP) and a small surplus was 
achieved in the first half of 1993. Apart from tight budget control, the good performance 
in 1993 must also be attributed to a better than expected performance in a number of areas: 
First, profit taxes were much higher than estimated, which seems to be related to the highly 
profitable re-export of (the often subsidized) goods originating from the former Soviet, 
republics. In addition, VAT revenues benefited substantially from improvements in tax 
collection and the change of the accounting law from cash to accrual basis. Finally, 
expenditure for unemployment benefits remained much lower than expected because of the 
relatively slow rise in unemployment. 
3.2.4. Internal monetary conditions 
Following the departure from the rouble zone in July 1992, the Bank of Latvia pursued an 
independent monetary policy geared towards stabilizing the economy and reducing 
inflation. It conducted a very stringent credit policy, reducing its credit allocation to banks 
in real terms, partly to counteract a large inflow of roubles from neighbouring countries 
and partly to offset the monetary impact of the Government borrowing in hard currency 
from state enterprises which was sold to the Bank of Latvia for domestic currency and then 
used to assist the drought-affected agricultural sector. The refinancing rate of the Bank of 
Latvia was raised in several steps from an annual 15% to 120%» in October 1992. 
However, real rates of interest for bank deposits reacted only slowly to these changes. The 
tight monetary stance of the Bank of Latvia led to an inflow of convertible currency which 
strengthened in the first half of 1993. The Bank of Latvia allowed the nominal and real 
exchange rate of the Latvian rouble (starting from March 1993, the lats) to appreciate 
significantly to partly reflect this higher demand for domestic currency, but it also 
accumulated a substantial amount of reserves to prevent a rise with potential damage to 
Latvia's external competitiveness. In order to stem a further currency inflow through 
downward pressure on market interest rates, thé refinancing rate was gradually cut back 
again in 1993; whereas interest rates on deposits have continued to increase, those on 
credits have started to come down slowly. 
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32.5. External developments 
The current account situation for the period 1 July 1992-30 June 1993 turned out 
substantially different from what had been originally expected. Instead of the planned 
deficit of nearly US$ 300 mio, the current account was in surplus in the order of US$ 70 
mio or some 4% of GDP. To some extent, there may still be a problem of underreporting of 
imports from former Soviet republics which are subsequently re-exported at high profits to 
Western countries. But this situation also reflects a better-than-expected balance in the 
services account (a surplus of about US$ 200 mio rather than some US$ 80 mio), which 
can be attributed to a good performance in the transport sector. 
The reorientation of Latvian exports towards Western countries continued vigorously. 
Export volumes to the CIS and Baltics fell by 19% in 1992 and by 51% in the first half of 
.1993 compared to the corresponding period of the previous year. At the same time, exports 
to the other countries expanded by 107% and 13%, respectively, in volume terms. Since 
1992, their share in Latvian export revenues is more than half. On the other hand, the 
decline of non-energy imports from the CIS and the Baltics (55% in 1992) decelerated 
substantially in the first half of 1993 to a 5% decline. There was also a slight deceleration 
of the contraction of non-energy imports from other countries (a 35% decline in 1992, 
followed by a 24% reduction in the first half of 1993). 
At the end of 1992, Latvia's external debt stood at 4% of GDP or some US$ 55 mio. 
Between mid-1992 and mid-1993, Latvia benefited from direct foreign investment in the 
order to US$ 50 mio. A crucial factor promoting this foreign investment activity has been 
the liberal foreign investment law which allows the repatriation of capital and transfer of 
shares in the event of liquidation. On the other hand, unresolved problems surrounding 
restitution and property rights, as well as the impossibility for foreigners to acquire land in 
Latvia have prevented a more dynamic development. From mid-1992 to mid-1993, gross 
convertible reserve holdings of the central bank increased from some US$ 100 mio to 
nearly US$ 300 mio which covers more than three months of imports. This reserve increase 
of some US$ 200 mio compares to an initial IMF target of a US$ 50 mio increase for this 
period. 
33. Review of the performance criteria attached to the EC loan 
The Memorandum of Understanding agreed between the Commission and Latvia, after 
consultation of the Monetary Committee, provided for a regular evaluation of progress 
made with respect to stabilization and structural adjustment policies undertaken. The 
quantified macro-economic performance criteria contained in the Memorandum follow 
those of the IMF stand-by arrangement and the structural adjustment criteria included in the 
Memorandum of Understanding were designed to evaluate the progress made in the area of 
privatization and enterprise restructuring, banking sector reform, foreign exchange and 
trade regime as well as foreign direct investment. A condition to release the second tranche 
of the loan is the successful review of progress in economic stabilization and reform, 
including the observance of performance criteria. 
The reviews of IMF conditionality concluded that the stabilization and reform programme 
was successfully implemented and that all performance criteria were met, to the satisfaction 
of the IMF Board. An EC mission to Latvia in November 1993 assessed the compliance 
with the structural adjustment criteria attached to the EC loan. It concluded that most 
criteria were met. Banking sector reform had progressed well, and supervision was 
strengthened. Latvia maintained the liberal trade, foreign exchange and investment 
regimes; it was expected that those investment protection agreements that had not yet been 
concluded with the EC would be concluded soon. In the area of privatization, progress was 
less forthcoming. Small-scale privatization advanced further, but large-scale privatization 
was hampered by the lack of a comprehensive body of legislation and of a centralized 
approach to privatization, as well as unresolved problems surrounding restitution and 
property rights. A Supplemental Memorandum of Understanding was agreed between the 
Latvian authorities and the Commission, according to which the disbursement of the 
second tranche would be linked to further progress in a number of these issues. 
Furthermore, in order to limit the Government's intervention in the allocation process, it is 
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stipulated that in principle the full amount of the second tranche of the EC balance of 
payments assistance would be channeled through the banking system and that the extension 
of a Government guarantee on these loans would be strictly controlled. It is expected that 
the signature of the Supplemental Memorandum of Understanding and the disbursement of 
the second tranche of the EC medium-term loan will take place in Spring 1994. 
3.4. Recent developments and prospects 
The decline in output appears to have stopped in the second half of 1993, and it is expected 
that GDP will grow in 1994. Unemployment continued to rise slowly to reach nearly 6% in 
December 1993, as the budget constraints enterprises are facing were continuously 
hardening. It is expected that progress in privatization will further increase the 
unemployment rate in the course of this ye2r. Inflation, which was reduced dramatically 
during the first half of 1993, increased to some 2% a month in the second half of the year, 
but this is attributable to seasonal factors and tax increases and does not indicate a 
departure from strict monetary control. In October 1993 a supplementary budget was 
approved by Parliament that authorized increases in expenditures including for pensions 
and public sector wages. Despite a concurrent increase in taxes, the budget recorded a 
deficit in the fourth quarter of 1993 following a surplus during the first three quarters. With 
the pick up of the economic growth and of imports in the course of the second half of 1993, 
the current account surplus is likely to have disappeared by the end of the year. 
External financial assistance received during the second half of 1993 and expected in 1994, 
includes loans from the G-24 countries (the remaining US$ 136 mio not yet disbursed by 
mid-1993), the World Bank and theTMF. The country has concluded a second arrangement 
with the IMF covering the period 1 October 1993 to 31 December 1994 (a combination of 
stand-by and systemic transformation facility) which should give Latvia access to 
additional purchases from the Fund for an amount of SDR 68 mio (some US$ 95 mio). 
This arrangement supports the authorities' comprehensive programme that aims at 
maintaining macroeconomic stability and reinforcing the transformation of the Latvian 
economy. The programme provides for the continuation ôf restrained fiscal and firm 
monetary policies, the rationalization of the trade regime and a speeding up of the 
structural reform efforts, particularly in the area of privatization. 
4. Lithuania 
41. Economic reform from mid-1992 to mid-1993 
411. Background 
Following the adoption of the Law on Economic Independence in late 1989, Lithuania 
prepared the legal framework for the removal of price controls and in February 1991, the 
Lithuanian Government permitted that enterprises increase their prices without the 
approval of Moscow, subject to a "profitability norm". Price liberalization progressed in 
several stages, and by early 1992, the majority of prices were liberalized. From the very 
beginning of economic reform the Government has stressed the importance of developing a 
strong private sector to support the transition to a market economy. The privatization 
programme included a combination of vouchers and cash sales. Vouchers were distributed 
to all eligible citizens in April 1991 and sales began in September 1991. By mid-1992, 
nearly 80% of small businesses had been privatized through auctions. With regard to large 
scale privatization, 600 of the 1100 large enterprises earmarked in the first phase of 
privatization had been privatized by mid-1992; i.e., on average 70% of their ownership was 
private. 
4.1.2. Objectives and features of the Government's reform programme starting mid-1992 
The two main objectives of the Government's economic programme for mid-1992 to mid-
1993 were to stabilize the economy by adjusting quickly to the terms of trade shock and to 
advance with structural reform. Eléments of the macroeconomic stabilization plan 
included the introduction of a new currency and departure from the rouble area, as well as 
-60-
the maintenance of sound fiscal, monetary and incomes policies. Elements of the structural 
plan comprised progress in building up a social safety net, implementing an anti-monopoly 
policy, privatization, enterprise reforms and the development of a legal and institutional 
framework for commercial activity. The programme targeted a decline in GDP of some 
22% for the programme year and a reduction of inflation to about 2% at the end of the first 
quarter of 1993. 
4.1.3. Price liberalization 
By Summer 1992, prices of most goods had already been liberalized. The main exceptions 
were energy products, rents, municipal and utility services, communications, alcohol and 
tobacco. Minimum support prices in agriculture had been removed and agricultural 
subsidies were limited in order to keep the budget under control. Energy prices were 
adjusted to the rise in import prices which accelerated in Fall 1992 when Russia stopped 
providing Lithuania with energy at preferential prices. After legislation defining unfair 
competition and monopoly practices came into force in November 1992, the Agency for 
Prices and Competition was established. It has the authority to examine prices charged by 
dominant enterprises (with market shares above 40%) and to freeze them for up to six 
months, but it does not have the authority to break up monopolies. In Spring 1993, profit 
margins were abolished and price controls on petrol, diesel, liquefied gas and coal were 
removed. 
4.1.4. Privatization 
The privatization process continued in the second half of 1992. By mid-December 1992, 
more than 1000 medium and large enterprises had been privatized through public share 
subscription, including almost 350 industrial plants. But following allegations of 
improprieties, the subscription was halted by Parliament and then resumed, whereas the 
auction of smaller enterprises was interrupted until the end of March 1993. The auction 
procedure was changed to permit the submission of closed registered bids and the 
transferability of vouchers. The new rules for privatizing medium- and large scale 
enterprises required that 50% of shares of an enterprise being privatized should be sold to 
employees (compared to the earlier 30%). Privatization of agricultural enterprises 
advanced well; in April 1993, a decree was issued to allow the privatization of otherwise 
unsaleable enterprises at a heavily discounted price. By mid-1993, nearly 90% of the 
capital of agricultural enterprises (up for privatisation) had been privatized. On the other 
hand, only little progress was made in the privatization of land. The restitution of 
agricultural land has been problematic because of the small size of parcels restituted and 
because of outstanding restitution claims that exceed the available agricultural land. The 
process of privatizing non-agricultural land has not yet begun. 
4.1.5. Financial sector and monetary reform 
In September 1992, the Bank of Lithuania was divided into two legally separate central and 
commercial banking activities. The new (Central) Bank of Lithuania was from then on 
responsible for monetary policy, the management of the payments system, and prudential 
control and regulation; until October 1992 it also had a monopoly on foreign exchange 
transactions which was subsequently abandoned. The new State Commercial Bank of 
Lithuania resumed all commercial functions of the former Bank of Lithuania inherited in 
1990 and 1991 from the former Gosbank, the Industry and Construction Bank and the 
Social Bank. Its assets account for roughly one third of total assets in the commercial 
banking system. Apart from the commercial banks, there are also the Savings Bank, which 
collects the bulk of household deposits, and the Agriculture Bank whose large credit 
volume has been mainly directed towards collective and state farms and in some cases also 
towards financing of government subsidies to the agriculture sector. These two state banks 
are holding claims against Gosbank in Moscow, which makes their financial situation 
fragile. 
After independence, when the Russian supply of banknotes fell short of the increasing 
demand caused by rapid inflation, the Lithuanian authorities decided to issue special 
coupons (Lithuanian Provisional Money (LPM) or talonas) to supplement the stock of 
rouble notes starting from 1 May 1992. In response to rouble inflows, the authorities 
declared that from 1 October 1992, talonas would be the only legal tender and provided if 
at 1:1 against rouble holdings, which was the first step of the currency reform. On 17 June 
1993, the Lithuanian national currency, the litas, was introduced and replaced the talonas 
over the following weeks. Prior to this second step the exchange rate of the talonas had 
been stabilized in order to ensure the success of the reform. The value of the litas is kept 
stable relative to a basket of major Western currencies. 
4 1.6. External Sector Policies 
Lithuania has made efforts to implement a liberal environment for imports. By Fall 1992, 
there were neither controls nor licenses on imports from any region. On the other hand, 
there were still export quotas and licensing, although steps were takrn in the course of 1992 
to remove a number of them. In June 1993, the Lithuanian authorities adopted a new trade 
system which provides for the removal of quantitative restrictions on exports, while export 
taxes were temporarily introduced for some formerly restricted goods. However the export 
of most foodstuffs and some agricultural inputs remained prohibited until 1 October 1993. 
The new system also foresees tariff rates for the majority of goods between 5 and 15%, 
with many goods entering tariff-free .and a few exceptions of higher tariffs (e.g., eggs,, 
sugar, butter, oil and a number of manufactured goods at 20-30%, and alcohol, tobacco and 
precious metals up to 100%). 
Following the replacement of the rouble by the talonas in October 1992, Lithuania has 
maintained a relatively liberal payments system, with a high degree of convertibility on 
current international transactions. All bona fide requests for making transfers and 
payments for imports of goods and services are satisfied. In early 1993, the Government 
decided to introduce a surrender requirement of 25% for export earnings of state 
enterprises in convertible currencies to the Bank of Lithuania. Commercial banks are 
permitted to borrow abroad and extend credits to non-residents and residents in foreign 
currencies. Resident firms may borrow foreign exchange either abroad or from Lithuanian 
commercial banks. Households and private enterprises can hold their savings in foreign1 
currency bank deposits. There is no restriction on the transfer of funds held by individuals 
or enterprises in foreign exchange accounts into or out of Lithuania. 
4.2. Macro-economic developments 
4.2.1. Production and employment 
By mid-1992, the disintegration of Lithuania's economic relations with the (former) Soviet 
Union had contributed to sharp production declines. After the GDP contraction of 13% in 
1991, the output decline accelerated in the course of 1992 as inputs were more difficult to 
obtain and, following the price liberalization in Russia, at significantly higher prices. In 
addition, agricultural output was negatively affected by a severe drought in Summer 1992. 
For the year as a whole, GDP is estimated to have declined by 38%. In the first half of 
1993, industrial production levelled off and the output contraction decelerated, reducing the 
output decline for mid-1992 to mid-1993 to some 30%. 
Until mid-1992, the output decline was barely reflected in official unemployment figures 
which stood below 1%. And over the following twelve months, the rate increased by less 
than 1/2 percentage point. However, hidden employment was estimated to be in the order 
of 7%, which is still relatively low in view of the severe output contraction seen in the past 
year. 
42.2. Inflation and wage developments 
Given the liquidity overhang, Lithuania's liberalization of prices, coupled with higher 
import prices, led to a steep price increase. By mid-1992, the year over year consumer price 
inflation stood at 865%. Monthly inflation rates picked up towards the end of 1992 when a 
preferential agreement with Russia on oil supplies ran out and higher import prices were 
passed on to consumers. In addition, price developments in Winter 1992 may have also 
reflected expansionary monetary consequences of the currency reform of 1 October 1992 
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linked to the exchange at par of talonas for roubles held in correspondent accounts as 
agreed with Russia. In the course of the first half of 1993, monthly inflation decelerated 
significantly as a consequence of strong tightening of monetary policy in Spring and the 
continuation of fiscal discipline. By July 1993, the monthly inflation rate, which averaged 
14% in the first half of the year, had decreased to 3%. Lithuania has maintained a tight 
incomes policy. In the second half of 1992, real wages dropped by more than half and 
have been kept stable in the course of the first half of 1993. 
4-2.3. Public finances 
The Lithuanian authorities have put great emphasis on fiscal discipline and have set the 
objective of balancing the general government budget during the period covered by the 
IMF arrangement (mid-1992 to mid-1993). Lithuania kept public expenditures under tight 
control during this period, which in fact resulted in a small surplus for the general 
government budget. The releases of funds to ministries were made conditional on actual 
Government receipts. This led to sharp reductions in the real wage and benefit for 
government employees. In 1993, revenues were strengthened through trade reforms and an 
increase in the general sales tax from 15 to 18%. 
4.2.4. Internal monetary conditions 
Until Lithuania's departure from the rouble area the scope for independent action in the 
monetary field was very limited. Monetary aggregates expanded rapidly during 1991 and 
1992. However, given the rapid rise in prices during these two years and the limited 
availability of banknotes, real money balances declined sharply prior to the first 
introduction of the talonas in Spring 1992. After the full introduction of the talonas in Fall 
1992, Lithuanian authorities pursued an independent monetary policy which led to an 
appreciation of the talonas exchange rate against the rouble. However, in the first four 
months of 1993, the talonas depreciated by 30% against the dollar, reflecting to some 
extent also expansionary monetary consequences of the currency reform, related to the 1:1 
rouble/talonas exchange of funds accumulated in the correspondence accounts. Evidence 
for the lack of confidence in the talonas was also given by large open positions in foreign 
exchange taken by Lithuanian commercial banks. 
Monetary policy was considerably tightened in Spring 1993. In early April, the Bank of 
Lithuania announced a near-tripling of reserve requirements for the following month and 
the introduction of auctions for central bank refinancing. These measures, combined with 
continued fiscal and wage discipline, produced a 25% appreciation of the exchange rate of 
the talonas against the dollar in May and June. This new policy stance prepared the 
introduction of the litas, Lithuania's national currency on 25 June 1993. After the 
Government replaced interest rate ceilings (annual lending rate of 25%») by minimum 
interest rates payable on deposits, to be applied at both state and commercial banks (20-
26%), interest rates rose but remained negative in real terms. This is above all due to the 
fact that the State banks, which have the major market share, set relatively low rates 
compared to the commercial banks. 
4.2.5. External developments 
Following a surplus position in 1991 and the first half of 1992, Lithuania's current account 
recorded a deficit in the order of US$ 150 mio (some 6% of GDP) from mid-1992 to mid-
1993. This is considerably lower than the original Fund estimates of a deficit of about US$ 
500 mio, mostly owing to a drop in interrepublican trade and, to some extent, to delays in 
the disbursements of external financial assistance. 
After a fall of 38% of export volumes in 1992 (caused by the 62%» decline in inter­
republican trade), export volumes broadly stabilized in the first half of 1993, compared to 
the first half of 1992 (a 22%» decline in interrepublican trade against a 18% increase in 
other trade). Import volumes, which had dropped by 57% in 1992, continued to decline in 
the first half of 1993, but at a considerably lower rate (16%, spurred by a 30% contraction 
in imports from former Soviet republics). Clearly, this demonstrates that Lithuania's trade 
reorientation continued as the country was exposed to world market prices. 
- 63 -
By mid-1993, Lithuania's external debt stood at some 8% of GDP or US$ 250 mio 
43. Review of the performance criteria attached to the EC loan 
The Memorandum of Understanding agreed between the Commission and Lithuania, after 
consultation of the Monetary Committee, provide for a regular evaluation of the progress 
towards stabilization and structural adjustment. The quantified performance criteria 
included in the Memorandum of Understanding are identical to those contained in the 11-
month IMF stand-by arrangement and the structural adjustment criteria, included in the 
Memorandum of Understanding were designed to evaluate the progress made in the area of 
price liberalization, enterprise reform, including in particular privatization, banking sector 
reform, foreign exchange, foreign trade and foreign direct investment. The successful 
review of progress in economic stabilization and reform, including the observance of 
performance criteria, is a condition to release the second tranche of the loan. • 
The reviews of IMF conditionally concluded that all performance criteria were met. An 
EC mission to Lithuania conducted in January 1994 concluded that the structural 
adjustment criteria attached to the EC loan were also met : the Government's role in price 
determination had been further reduced; banking supervision had been strengthened, 
privatization and restitution had progressed; liberal foreign exchange and trade regimes 
were maintained. There was however less progress in other areas including the 
restructuring and privatization of the banking system; the revision and implementation of 
bankruptcy legislation, the revision of central and commercial banking laws and the 
conclusion of double taxation agreements with Member States. A Supplemental 
Memorandum of Understanding has been negotiated and is expected to be concluded 
shortly, according to which the disbursement of the second tranche would be linked to 
further progress in a number of these isues. In addition, it stipulates a series of conditions 
that should allow the proper absorption of the second tranche through the banking system, 
including the intensified absorption of technical assistance. It is expected that the 
Supplemental Memorandum will be signed in Spring 1994, which should be followed by 
the disbursement of the second tranche shortly afterwards. 
4.4. Recent developments and prospects 
There are signs that the output stabilized in the second half of 1993. Unemployment 
remains relatively low in light of the lower production levels. Following its decline during 
the first half of 1993, inflation picked up again in the second half of the year to monthly 
rates of 4.5%. This is partly due to the fact that the central bank expanded monetary supply 
more than foreseen in order to avoid an appreciation of the litas as a consequence of capital 
inflows. The current account appears to have deteriorated further in the second half of 1993 
In September 1993, Lithuania purchased the remaining tranche (some US$ 18 mio) under 
the first IMF stand-by arrangement. Lithuania has concluded a second arrangement with 
the IMF covering the period up to end-1994 (a combination of stand-by and systemic 
transformation facility). This will give the country access to purchases from the Fund in 
the order of US$107 mio over a 17-month period. This arrangement supports the 
authorities' comprehensive programme that aims at building on the stabilization and 
structural adjustment programme achieved. The main programme goals are to raise real 
growth to sustainable levels while reducing inflation by end-1994 to single digits at an 
annual rate. The programme will attempt to achieve this by maintaining macroeconomic 
balance and building confidence in economic policymaking, improving the supply response 
of the economy through continuing structural reform, directing foreign financing to the 
most productive uses, and, through these policies, attracting foreign investment. 
64-
Vm. ALGERIA 
1. Introduction 
On June 28 and 29, the European Council agreed in principle to provide medium-term 
macro-financial assistance to this country in support of an ambitious macro-economic 
reform programme in the context of political liberalisation. Accordingly, on the basis of a 
Commission proposal and after a favourable opinion by the European Parliament, the 
Council decided in September 1993 to grant an ECU 400 million loan to Algeria, to be 
disbursed in two tranches (Decision 91/510/EEC of 23 September 1991). 
The loan agreement and the corresponding Memorandum of Understanding specifying the 
macro-economic conditions for disbursement of the two tranches, were signed in Algiers 
on 5 December 1991. 
The disbursement of the first tranche (of ECU 250 million) was subject to two conditions: 
The conclusion of an agreement on a Stand-By arrangement with the IMF and a 
structural adjustment loan with the World Bank, 
The conclusion of an agreement between Algeria and its commercial bank creditors on 
improving the country's future debt servicing and repayment profile through new 
loans and/or new refinancing agreements. 
Algeria reached an agreement with the IMF in May 1991 for a Stand-By facility of SDR 
300 million (US$ 430 million) and with the World Bank in June 1991 on a US$ 350 
million Enterprise and Financial Sector Adjustment Loan (EFSAL). 
In October 1991, the Bank of Algeria also reached an agreement with a consortium of 
commercial banks, led by the Credit Lyonnais, for a syndicated loan of US$ 1,454 million. 
This loan allowed an effective re-profiling of commercial debt over a longer period. 
Burden-sharing with private creditors was an essential component in this loan agreement. 
Other agreements, including the US$ 147 million loan by the Japanese EXQM Bank (April 
1991) and an Italian government guaranteed inter bank loan facility of US$ 7.2 billion 
(May 1991) also contributed to an effective refinancing of Algerian foreign debt. 
In the circumstances, the Commission considered that the conditions for the disbursement 
of the first tranche were satisfied and the funds were released in January 1992. 
In accordance with the Memorandum of Understanding, the release of the second tranche 
was subject to two sets of conditions : 
The respect of the quantitative macro-economic performance criteria agreed in the 
context of the IMF programme; 
A positive assessment by the Commission.of the progress accomplished in structural 
reform programmes, including : convertibility of the dinar, price and import 
liberalization, adoption of legislative measures on a Commercial Code, bankruptcy 
procedures, the establishment of a stock exchange and further liberalization of foreign 
direct investment. These conditions were consistent with the economic adjustment 
programmes agreed between the Algerian authorities and the IMF and the World 
Bank. 
The lack of compliance with the macro-economic performance criteria as well as 
insufficient progress on structural reform have, so far, prevented the release of the second 
tranche. 
Progress with respect to those economic programmes is assessed hereafter. 
- 65 -
2. Economie developments in 1992-1993 
The Algerian adjustment and reform programme, which started in 1991, was designed to 
foster growth through the implementation of liberalization measures, while reducing 
inflation by pursuing tight monetary and fiscal policies and achieving a viable external 
situation. The objective for 1991 was an increase by 4.5% of real GDP in 1991 (against a 
decline of 1.5% in 1990). Annual inflation was targeted at 35% and the budget was 
expected to gradually reach a surplus of 4.8% of GDP, mainly through increased revenue 
from the hydrocarbon sector which accounts for two thirds of all government revenue. On 
the external side, the government's medium-term objective was to maintain a significant 
current account surplus so as to make possible a reduction in the stock of Algeria's heavy 
external debt. An increased inflow of foreign financial resources and a reduction in the 
external debt service were also key elements in this respect. 
The targets of this IMF-supported programme were met until the end of 1991, but it went 
off-track in early 1992. Socio-political tensions led to a softening of the incomes, fiscal and 
monetary policies and to an increase of credits to the public enterprises sector. These 
factors fueled inflation which remained high throughout 1992 and is expected to accelerate 
in 1993. 
The steady appreciation of the real exchange rate throughout 1992, together with the high 
level of debt service payments, have created a tight situation in the exchange market and 
delayed the necessary move towards convertibility of.the national currency. Furthermore, 
from late 1992 onwards, a gradual fall in hydrocarbon world market prices had a serious 
negative impact on the balance of payments and the public finance situation, since over 
90% of Algeria's foreign earnings come from export of oil and gas, which also constitute 
the main source of revenue for the budget. 
2.1. Domestic output and demand 
Real GDP growth was modest in 1992 (some 2.8%) and the introduction of restrictive 
foreign exchange allocation procedures, in late 1992, are likely to increase the shortages of 
imported parts and supplies to the manufacturing and construction sectors and have a 
serious negative impact on GDP growth in 1993 with adverse implications for the labour 
market. 
Growth in agriculture reached 4.8% in 1992, mainly because of good weather conditions 
but deteriorating conditions in 1993 may lead to a less favourable performance. Value-
added in the hydrocarbon industry was growing steadily in 1992, despite a slight decrease 
in output from 108 million barrels in 1991 to 106.5 million barrels in 1992. For 1993, 
uncertainties concerning world market prices could also influence developments in this 
sector. 
2.2 The budget 
Fiscal policies were relaxed substantially in 1992. Government current expenditures rose 
by 50% in nominal terms, largely because of strong rises in the wage bill (22% in real 
terms) and social transfers (50% in real terms). Revenue rose by 25% only owing to the 
appreciation of the effective exchange rate and the resulting lack of buoyancy of 
hydrocarbon receipts, which account for about two thirds of all fiscal revenues. 
In view of the slow-down in the public enterprises reform programme and of the 
appreciation of the effective exchange rate, prospects for improvement of the budgetary 
situation are bleak. Moreover, the appreciation of the Dinar and the resulting lack of 
increase of .budgetary revenue from hydrocarbon exports (two thirds of all revenue) are 
seriously aggravating the overall treasury balance, which turned from a surplus of 4.3% in 
1991 to a deficit of 0.6% in 1992 and is projected to reach a deficit of around 9% of GDP 
in 1993. 
-66-
2.3 Trade balance, exchange rate developments and external debt 
Exports have decreased from US$ 12.6 billion in 1991 to US$ 11.6 billion in 1992. They 
are not expected to increase in 1993, mainly due to a stagnation in the hydrocarbon exports. 
Imports increased from US$ 7.8 billion in 1991 to US$ 8.2 billion in 1992 and are 
projected to reach US$ 8.4 billion in 1993. As a result, the trade balance surplus 
deteriorated from 11%» of GDP in 1991 to 8% in 1992 and is projected at 6% of GDP in 
1993. A slow reduction in interest payments abroad from US$ 2.4 billion in 1991 to an 
estimated US$ 2.2 billion in 1993 should somewhat limit the negative impact on the 
current account, which is expected to deteriorate from a US$ 2.6 billion surplus in 1991 to 
a US$ 1.1 billion deficit in 1993. 
Since the mid-80s, the authorities pursued a policy of gradual depreciation of the Dinar 
(more than 70% between 1985 and 1992) to reduce the gap between the official and 
parallel market rate and slowly achieve current account convertibility. In 1992, the 
government changed this policy and stabilisation of the nominal exchange rate became the 
new objective. This resulted in a 22% increase in the real effective exchange rate. This 
appreciation is likely to continue in 1993. 
The external debt stock has been reduced slightly from a peak of US$ 27.2 billion in 1991 
to US$ 26.2 billion end 1992 and is expected to decline further in 1993 to US$ 25.7 billion. 
Total external debt service will fall slowly from a peak of US$ 9.6 billion in 1991 (76% of 
exports) to around 9 billion in 1993. However, in terms of exports, the burden of debt 
servicing will somewhat increase from 76% of exports in 1991 to an estimated 80% in 
1993, whereafter it is expected to decline again. 
The parallel market rate stood at approximately 60 Dinar per US dollar in June 1993, 
compared to an official rate of 22.5 Dinar per US dollar, which is clearly not a market 
clearing rate. The spread between official and parallel market rates has widened, 
increasing from 1:2 end 1991 to almost 1:2.7 at present. 
2.4. Money and credit 
Monetary policy remained accommodating during the first half of 1991 and became more 
stringent from July onwards only. However, given the dimensions of the increase in credit 
in the first half, overall results for 1991 still show an increase by 20.9% of the broad 
money stock, somewhat above the programme target of 18.8%. But the increase in credit 
was entirely allocated to households and enterprises (+21.1%») while credit to the 
government was squeezed (-2.1%»). 
Monetary policy further relaxed in 1992. Domestic credit increased by 26.1% of the broad 
money stock. Again, most of the increase went to households and enterprises (23.3%) but 
credit to the government was also allowed to grow slightly (2.8%) to finance part of the 
widening budget deficit. For 1993, credit growth is expected to remain around this level. 
Real interest rates remained negative throughout 1991 and 1992, which constitutes a 
serious disincentive to savings. Inflation ran over 32%» in 1992 while interest rates on 
savings' deposits remained at 8% and on 1-year treasury bonds at 10%». 
3. Status of the reform process 
Economic reform has taken place against a difficult political background. Following 
protests in October 1988, a new multi- party constitution was adopted in 1989. The Islamic 
FIS swept to victory in local and municipal elections in June 1990 and in the first round of 
national legislative elections in December 1991. The second round, scheduled for January 
1992 was suspended and president Chadli resigned. He was replaced by a "Haut Conseil 
d'Etat", presided by M. Boudiaf. A period of violent confrontation with the FIS started, 
leading to the dissolution of the FIS and the assassination of Boudiaf in June 1992. He was 
succeeded by A. Kafi and a new government was formed by Prime Minister B. Abdesselam 
who pursued a policy of economic austerity and military confrontation with the FIS. Lack 
- 67 -
of progress in solving the political and socio-economic problems resulted in the 
replacement of Abdesselam with a new Prime Minister, R. Malek, in August 1993. 
The Abdesselam government produced a "Work Programme" in September 1992 which 
reiterated the commitment to economic reforms and a more liberal market-based economy. 
However, it. also emphasized that the social and political situation required strong 
government intervention and austerity policies which could not be left to the market. 
Economic reforms would be continued once the internal political problems and the external 
debt crisis would be overcome, after a 3-5 years period. 
After a series of substantial wage increases in the public sector, which had a negative 
impact on the budget and on inflation, a "Social Pact" was concluded in 1992 between the 
government and the labour unions, based on job security in return for a wage freeze and 
restrained price increases. 
Economic reforms, particularly imports and currency liberalization introduced under 
president Chadli, have been slowed down. Emphasis has been put on economic austerity 
with priority utilisation of convertible currency for servicing of external debts, without 
rescheduling. Further depreciation of the dinar has been excluded. 
Import controls have been put in place in October 1992, which are likely to slow down 
economic growth and deepen the recession because of shortages of imported inputs. 
Foreign currency is allocated to banks for transactions not exceeding US$ 100,000. 
Transactions exceeding this amount or "strategic" imports are decided on a case-by-case 
basis by an ad-hoc Inter-ministerial Committee. The new rationing system classifies 
imports in four categories: 
a) "strategic" imports (goods related to hydrocarbon production, essential consumer goods 
like cereals, agricultural inputs, medicines, etc.) for which official foreign currency 
reserves are available and subject to a decision by an Inter-ministerial ad-hoc Committee; 
b) imports to enhance production and investment activities for which foreign currency 
allocations are decided by the Intei-ministerial ad-hoc Committee if they exceed US$ 
100,000, by commercial banks for amounts below this limit; 
c) "authorized" imports for which no official foreign exchange cash or credit) is made 
available but which can be financed on private foreign exchange accounts, 
d) "luxury" goods for which imports are "suspended" and for which neither official nor 
private foreign exchange can be used; barter deals are forbidden too. 
In June 1993 the government proposed to partially liberalize the exchange rate with the 
introduction of a two-tier exchange rate mechanism: an official (fixed) rate for the exports 
of oil products, debt servicing and the imports of essential goods, and a (floating) free 
market rate for all other transactions (other exports, transfers by immigrants, transactions 
on residents' foreign currency accounts). 
With regard to reforms in the financial and enterprise sector, the government presented an 
Economic and Financial Structural Adjustment programme that was supported by a World 
Bank loan (EFSAL). The programme aimed at improving the efficiency of the banking 
system (new prudential ratios, opening the domestic market to foreign banks) as well as a 
reform of the public enterprises sector. The government has granted or is about to grant 
financial autonomy to 363 public enterprises but their (partial) privatization and financial 
restructuration has slowed down since early 1992. For the 22 remaining non-autonomous 
public enterprises, audits and financial restructuring plans are in preparation. 
A reform programme for the crucial housing sector has been introduced in 1993, focusing 
on increased private sector participation in the construction of dwellings, removal of rent 
caps, a reorganization of the housing credit system, replacing general interest rate subsidies 
by a targeted housing assistance programme, reform of public construction enterprises and 
public sector construction materials suppliers. 
-68-
In theframework of the IVth Protocol on technical and financial cooperation between the 
Community and Algeria, the Commission has made available in July 1993 a 70 mECU 
grant as a contribution to this reform programme. This grant will finance a sectoral 
imports programme of construction materials to finish the construction of about 100,000 
housing units. Counterpart funds from the import programme will be used to finance the 
construction and rehabilitation of housing units. This programme was developed in close 
collaboration with the World Bank, which has also instructed a housing sector loan with a 
construction material import programme (March 1993). 
4. A review of macro-ecocomic performance and structural reform criteria 
The Memorandum of Understanding between the Community and Algeria specified two 
sets of conditions for the release of the second tranche (150 mECU). The first set refered 
to the quantitative criteria in the Stand-By arrangement between Algeria and the IMF and 
ensured compatibility between this arrangement and the Community's Balance of Payments 
Support. The second set refered to a number of specific economic reform measures to be 
implemented by the government. 
4.1- Performance criteria agreed with the IMF 
On 3 June 1991, Algeria reached an agreement with the IMF on a 10-month Stand-By 
facility for an amount of SDR 300 million. The first tranche was immediately disbursed. 
This facility was accompanied by an external contingency mechanism of SDR 210 million 
under the Contingency and Compensatory Financing Facility (CCFF). The performance 
criteria and indicative targets in this programme included quantitative targets on changes in 
net domestic assets, treasury debt reduction, credit to public enterprises, external borrowing 
and international reserves. 
The first review of performance criteria was concluded in November 1991, based on 
performance through September 1991, and led to the release of the second tranche. In fact, 
performance criteria were met until December 1991, taking into account the additional 
measures taken by the government at the end of fiscal year 1991. Total purchases 
amounted to 225 mSDR by the end of 1991. 
From early 1992 onwards the programme got off-track. Monetary and budgetary 
performance criteria were not met. The second review, due in March 1992, was never 
completed and the final purchase was never made. No new programme has been agreed 
upon since. 
42. Structural reform criteria 
Five economic reform measures have been targeted in the Memorandum of Understanding 
concerning the Community loan: current account convertibility of the Dinar, liberalization 
of prices, liberalization of imports, legislative measures and protection of foreign direct 
investments. 
Progress in price liberalisation has been encouraging, with a gradual move from fixed 
prices to controlled margins for most consumer goods and the total liberalisation of prices 
of farm products. By June 1993, the prices of only three basic foods remain subsidised. 
Prices of public utilities, transport and fuel still need to increase further to reflect economic 
costs. 
Some progress has been made with respect to the legislative measures foreseen in the 
Memorandum of Understanding. The government has introduced an Investment Code and 
a Commercial Code which will substantially improve the legal environment for private and 
public enterprises and will also protect and liberalize foreign direct investments. Both 
these Codes are operational now. The regulatory environment for the establishment of 
foreign banks in Algeria has also been liberalised. 
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Major problems remain however with respect to the move towards current account 
convertibility of the Dinar and liberalisation of imports. In September 1992 the 
government backtracked on earlier exchange rate liberalisation policies by introducing a 
stringent foreign exchange rationing system combined with rigid import controls. This 
halted the process of gradual depreciation of the Dinar, started in 1985, and actually led to 
an appreciation of the real effective exchange rate, thereby reducing the competitiveness of 
the Algerian economy and creating internal price distortions. The announced introduction 
of a two-tier foreign exchange market in 1993 constitutes a positive step in the right 
direction but further progress appears necessary. 
5. Assessment and prospects 
The government has made some progress in the implementation of structural reform 
measures over the last two years. Prices of most goods have been liberalized in principle, 
although some forms of administrative control apparently remain. Legislative measures 
have also been taken to improve the legal environment for commercial enterprises and 
foreign investments. 
Major problems remain with regard to the introduction of full current account 
convertibility of the Dinar and the liberalization of imports. The fixed exchange rate policy 
has led to a considerable appreciation of the Dinar and a growing budgetary deficit which 
keeps the economy under inflationary pressure. A more flexible two-tier exchange market 
system might by considered as a "second best" solution for a short transitory period 
towards full convertibility. The combination of a slow-down in the reform process and a 
restrictive imports policy have brought real economic growth to a virtual standstill while 
inflationary pressure has not been stabilized. 
Because of the discontinuation of the macro-economic stabilisation programme agreed with 
the IMF and lack of progress in key economic reforms, conditions for the release of the 
second tranche (ECU 150 million) of the Community loan have not been met. 
Faced with a particularly difficult political and economic environment Algeria has recently 
resumed discussions with the IMF on "a new programme to be supported by a stand-by 
arrangement. Key policy measures associated with the new programme would include : the 
liberalization of the exchange rate regime and foreign trade; tight fiscal and monetary 
policy; public enterprise reform and domestic price liberalization. Owing in particular to 
the recent decrease in energy prices, it is expected that Algeria will have to meet 
considerable external financing needs in 1994/95 and that without substantial official 
assistance from abroad the new programme under discussion with the IMF could not be 
implemented. 
The Community has recently indicated in this respect that the macro-financial cooperation 
with Algeria initiated by the first tranche of the 1991 balance of payments loan will be 
pursued, including if appropriate through new initiatives, on the basis of the conclusions of 
the discussions underway with the IMF. 
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IX. ISRAEL 
1. Introduction 
On 22 July 1991, the European Council, taking into consideration the adverse economic 
consequences of the Gulf conflict, on the basis of a Commission proposal and after a 
favourable opinion by the European Parliament, decided to grant an ECU 160 million loan, 
accompagnied by a ECU 27.5 million interest rate subsidy, to the State of Israel and a ECU 
60 million grant to the Palestinian population of the Occupied Territories, and authorized 
the Commission to negociate the terms and conditions with the bénéficiai ries (Decision 
91/408/EEC of 22 July 1991)4. 
The loan agreement between the Community and Israel and the attached Memorandum of 
Understanding were signed on 16 December 1991. The terms and conditions set out in the 
Memorandum of Understanding were the following: 
i) The loan will be disbursed in a single tranche following the modalities set out in the 
loan agreement; 
ii) The interest subsidy will be disbursed in successive instalments in accordance with 
the provisions in the loan agreement; 
iii) The funds are made available for the purpose of financing the essential imports needs 
of the population of Israel; . 
iv) The Israeli government will submit to the Commission, no later than one year 
following the disbursement of the aid, a report on the utilisation of the funds. 
The loan, with a maximum duration of seven years, was released in January 1992. At the 
same time, the amount of the interest rate subsidy was put into an account at the Bank for 
International Settlements for payment to "the Bank of Israel in succesive tranches on dates 
when interest payments are due. In accordance with paragraph 2(iv) of the Memorandum 
of Understanding, the Government of Israel informed the Commission on 26 October 1992 
that the funds had been used entirely for the purchase of imported fuel. 
In the Memorandum of Understanding, the Community took note of the Israeli 
government's firm intentions to ensure a sustainable external financial situation, contain the 
budget deficit, proceed with the liberalisation of the economy and ensure the appropriate 
conditions for a steady development of foreign direct investment in Israel. 
Economic policies and developments in the Israeli economy are assessed hereafter. 
2. Recent economic developments 
Since 1989, the Israeli economy was subjected to two major economic shocks. First, the 
Gulf War caused a slump in the export and tourism industries and thereby increased the 
trade balance deficit. The adverse consequence of the Gulf War on the external balance led 
to the approval of the ECU 160 million Community loan as well as the approval of an SDR 
266 million Compensatory and Contingency Financing Facility by the IMF in March 1992. 
Second, a massive wave of new immigrants, mainly from the Former Soviet Union, 
increased the population by around 10%. This required substantial absorption efforts both 
in the housing sector and in the labour market. The authorities' strategy has been to 
The utilisation of the ECU 60 million grant to the Palestinian population of the Occupied Territories has been 
discussed in a separate report. 
-71 -
provide the immigrants with subsistance grants, housing and education but to abstain from 
direct intervention in the labour market, which could be counterproductive in the long run. 
Emphasis was put on improving the business environment, which would lay the basis for a 
gradual absorption of the immigrants into the labour market. 
2.1. Domestic output, prices and employment 
The rate of growth of real GDP gradually increased over the period 1990-1992, from 5.4% 
in 1990, to 5.9% in 1991 and 6.5% in 1992. The inflow of immigrants contributed 
substantially to this demand-driven growth performance. Overall private consumption 
demand increased by 12.4% in 1991 and spending on residential housing increased by 76% 
in the same year. From 1992 onwards, a decrease in the number of immigrant arrivals, 
from a monthly average of over 20.000 in 1990-91 to around 7.000 in 1992, and the 
resulting build-up of a stock of unsold housing units (20.000 end 1992), slowed down 
construction activity (+4.5%). But strong export performance (+12.7%), after the Gulf 
War slump, took over as the main driving force behind economic growth. In March 1993, 
the closure of the borders with the Occupied Territories led to a slow-down in economic 
activity. But this trend is likely to be reversed after the signature of the peace agreement 
with the Palestinians. 
In spite of this strong economic performance and a 4% annual average increase in 
employment over the past three years, the rapid growth in the labour force resulted in an 
overall increase in the unemployment rate from 8.9% in 1989 to 11.2% in 1992. New jobs 
were mainly concentrated in the construction industry and nearly two thirds of these jobs 
were taken up by immigrants. As a result, the unemployment rate among immigrants 
declined from 38 % in 1991 to 28% by end 1992. In the first half of 1993, the 
unemployment rate continued to drop against the background of the closure of the borders 
of the Occupied Territories which led to a partial substitution of Palestinian workers with 
Israelis. 
The substantial increase in the labour force resulted in a nominal wage increase below 
inflation levels. In 1991, real wages decreased by 3.2% while labour productivity 
increased by 2.5%. In 1992, this tendency was somewhat reversed with a real wage 
increase by 0.9%, merely reflecting the fact that certain wage contracts had been negotiated 
on the basis of a higher expected rate of inflation, and a reduction in productivity by 1.5%. 
Consumer price inflation varied between 18 and 20% p.a. over the period 1989-91. In 
1992, it slowed down to 9.4%, the lowest level for the past decade. A reduction in the 
budget deficit, a more flexible labour market with lower real wages and a fall in housing 
prices, have contributed to this achievement. In the first half of 1993, inflation accelerated 
to around .12% in annual terms, mostly due to a rebound in housing prices after the fall in 
the second half of 1992. But a slow-down occured again in mid-1993. 
Fiscal policy 
Whereas overall government revenue and expenditures amounted to around 70% of GNP in 
1985, these ratios were reduced to 53.7% for revenues and 58% for expenditures by 1992. 
Taxation policy shifted away from direct toward indirect taxes (VAT rate increase from 16 
to 18%). In 1992, a reduction in top marginal income tax rates (from 60 to 48%, 
subsequently increased to 50% in August 1993)) and corporate taxe rates (from 61 to 41%) 
was introduced. 
On the expenditure side, defense spending was reduced from 12.75% of GNP in 1985 to 
8.75% in 1992. Defense imports, mainly financed by foreign grants, also fell from 6 to 
2.75%) of GNP over the same period. On the other hand, social services spending, 
including transfers to immigrants, increased from 10 to 15% of GNP between 1985 and 
1992. 
Since 1990, budgetary policy has been fundamentally affected by the objective of 
absorbing the wave of immigration, through subsistence grants, providing for housing 
needs and a variety of employment and investment incentives. 
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The initial cash grant for arriving immigrants, completed with health insurance and 
unemployment benefits, altogether amounted to an average US$ 10.000 per year per 
immigrant. Wage subsidies for immigrants up to one third of the salary and up to two 
years were introduced in July 1991. Some 30.000 employees have so far participated in 
this programme. 
From the acceleration of immigration in 1990 up to mid-1992, the authorities' housing 
strategy was based on the belief that the housing market would react too slowly and needed 
additional incentives. Public spending on immigrant housing was channeled through direct 
construction, guaranteed sales of houses build by private constructors and mortgage 
subsidies. In order to avoid a worsening budget deficit, these housing sector incentives 
have been financed by a significant reduction in the proportion of public spending on 
defense, a temporary 5% income tax surcharge (cancelled in August 1993) and an increase 
in the VAT rate. In the second half of 1992, following a slow-down in immigration, the 
newly elected government scaled down spending on housing by the cancelation of 12.000 
planned housing units and an elimination of the housing sales guarantee for private 
contractors. 
Public infrastructure expenditure has stabilised at a very low 2% of GNP in recent years, 
thereby contributing to road congestion which presently constitutes a serious bottleneck to 
economic growth. A 30% increase in infrastructure investments is planned under the 1993 
budget. 
In spite of the increased social expenditure due to immigrant arrivals, the overall budget 
deficit declined from 4.25% of GNP in 1991 to 2.75% in 1992. 
Outstanding public debt has declined from 154 to 129% of GNP between 1987 and 1992 
but remains very high. Interest payments represented 8% of GNP and 14% of government 
expenditure in 1992. 
2.3. Trade balance and external debt 
In the wake of the Gulf War, exports stagnated around US$ 12.2 billion in 1990 and 1991. 
Imports, on the other hand, continued to grow, fueled by demand stemming from the 
inflow of immigrants. As a result, the trade balance deteriorated from a US$ 2.8 billion 
deficit in 1990 to a US$ 4.8 billion deficit in 1991. In 1992, the trade balance deteriorated 
further to a US$ 5.4 billion deficit. It is expected to stay around that level for 1993. 
The services balance improved substantially following a post-war rebound in tourism, from 
a US$2.5 billion deficit in 1991 to a US$ 1.8 billion deficit in 1992. By contrast, 
intergovernmental transfers fell back to pre-war levels around US$ 3 billion, after a US$ 
3.8 billion peak in 1991. 
Owing to a significant increase in both private and public unrequited transfers, from US$ 
5.3 billion in 1990 to US$ 6.7 billion in 1991 and 6.9 billion in 1992, the current account 
remained roughly balanced. 
Since the Gulf War, direct investments and other long-term capital have registered a net 
outflow. The overall balance remained marginally positive due to short-term capital 
movements. Only in 1992 did a US$ 1.2 billion (1.8% of GDP) deficit occur for the first 
time since 1988, provoked mainly by an outflow of short-term capital (US$ 1.7 billion). 
The credit guarantees, obtained from the US government at the end of 1992 (US$ 10 
billion over 5 years or US$ 2 billion per year), will enable the authorities to promote 
productive investments in the domestic economy while building up reserves. 
Total external debt stood at US$ 23.5 billion at end 1992. The gross external debt service 
ratio improved substantially, from 36.8% of total exports in 1990 to 29.2% in 1992. Net 
external debt service also fell from 29.1 to 22.3% over the same period. 
-73-
2.4. Exchange rate, money and credit 
Until 1991, Israel maintained a relatively fixed exchange rate pegged to a currency basket 
and floating within a band around a midpoint rate, with periodic realignments to 
compensate for the loss of competitiveness stemming from high domestic inflation. In 
December 1991, a more flexible "diagonal band" exchange rate system was introduced, 
whereby the midpoint was devalued daily vis à vis a currency basket and at a pre-
announced rate, while the exchange rate floated freely within a band around this moving 
midpoint. This avoided speculative attacks on the national currency, the Shekel, in 
anticipation of devaluations while competitiveness was assured by setting a pre-announced 
devaluation rate consistent with the expected domestic inflation rate. 
For 1992, the crawl pace of depreciation vas fixed at 9%, consistent with an expected 
inflation rate of 14%. Inflation turned out to be lower than expected (9.4%), which 
resulted in a real depreciation of the Shekel by 6%. For 1993, the crawl pace was set at 
8%, against an expected inflation rate not exceeding 10%. In July 1993, the expected 
annual inflation rate was reviewed downwards to 8% and the crawl pace was slowed down 
to 6%. 
In the early parts of 1991, interest rates were kept low to stimulate investment. Following 
an unexpected 3% devaluation in March 1991, which was perceived by the market as a 
change in exchange rate policy, interest rates had to increase to dispel this view. As capital 
inflows continued during 1992, domestic interest rate lowered again, against a background 
of decelerating inflation and economic growth. Moreover, pressure by the Bank of Israel 
on commercial banks to reduce the borrowing-lending spread, as well as increased 
competition on financial markets, further reduced lending interest rates. By mid-1993, a 
temporary increase in interest rates occured against the background of a slight rebound in 
inflation. Real interest rates remained positive throughout the period 1991-93. 
Until the mid-80s, the credit market used to be dominated by the government need to 
finance persistent large budget deficits. The reduction of this deficit, together with a 
deregulation of financial markets, increased the share and stimulated growth of unregulated 
credit to the private sector. Short-term bank credit increased by roughly 27% in both 1991 
and 1992. 
3. Status of the reform process 
The Israeli authorities have stressed the crucial role of structural reforms, aimed at 
improving competitiveness and efficiency, in their strategy to promote investments and 
accelerate economic growth. 
At the start of the reform process, the state owned around 85 business companies, with an 
estimated net worth of US$ 17 billion representing over 25% of GDP, strategically 
involved in the banking, communications, construction, energy, transport and defense 
industries. In 1991 and 1992, the government planned to sell 20 companies but effectively 
sold only 7 totaling only US$ 250 million in government revenue. The need for structural 
reform prior to privatisation, legal problems and vested interests, all provided obstacles to 
the success of the privatisation programme. For 1993, a revenue of US$ 400 million is 
budgeted under the privatisation programme, which is too small compared to the net worth 
of state enterprises to be considered a substantial reform of the economy. However, in 
August 1993, the Treasury announced an acceleration of the privatisation programme, with 
emphasis on the banking sector. 
Public sector wages have remained virtually constant in real terms over the past three years, 
while private sector wages have declined by 7% in real terms over the same period. A 
public sector wage négociation was conducted in 1992 which aimed at reflecting 
productivity differences in the wage structure and breaking the link between public 
enterprises and public service wages. Although the private sector labour market has been 
able to absorb a large part of immigrant labour, increased flexibility could enhance its 
absorption capacity. Reforms in the minimum wage law and in shift-work regulations and 
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authorisation of private employment bureaus are required but no substantive reforms have 
been proposed yet. 
The authorities concluded free trade agreements with the United States, the European 
Community (currently under review) and the EFTA countries, and have implemented a 
programme to liberalise trade with "third" countries. All quantitative import restriction 
have been replaced with an equivalent tariff. Tariffs are scheduled to be reduced to a 
maximum of 8-12%) over 5-7 years. Taxes on imported tourist services and on travel 
abroad have been abolished. A 2% import duty surcharge and a 2% export subsidy, which 
constituted trade restrictions under GATT rules, have been abandoned in July 1993. 
Consequently, the Israeli economy has, for the first time in its history, a single exchange 
rate for all transactions. 
Exchange restrictions have been liberalised with the objective of establishing full current 
account convertibility. Israel accepted the obligations under Article VIII of the IMF 
Articles of Agreement on 21 September 1993. 
4. Assessment 
Since the introduction of the structural reform programme in the mid-80s, the Israeli 
economy has been substantially liberalised, notably the financial and foreign trade sectors 
While the results of the privatisation programme have, so far, remained below expectations, 
the state's share in the economy has been reduced. The decrease in the government budget 
deficit, together with a monetary and exchange rate policy aimed at nominal stabilisation, 
have considerably lowered inflationary pressure. 
On top of these structural changes, the authorities have managed succesfully to cope with 
the economic consequences of the Gulf War and the massive inflow of immigrants. 
Prudent budgetary policies, aimed at satisfying immigrants' subsistence needs, combined 
with temporary tax measures, have prevented a worsening budget deficit. 
The rather slow privatisation process, combined with persistent high public debt-to-GNP 
ratios, continue to weigh on the public'deficit and leave little room for a highly desirable 
increase in public investment in basic infrastructure which could, in turn, be a driving force 
behind continued economic growth in the next few years. 
The Community balance of payments loan has contributed to a stabilisation of Israel's 
external financial situation in the wake of the Gulf War and permitted the continuation of a 
prudent monetary policy which has finally resulted, in September 1993, in the achievement 
of full current account convertibility and the acceptance of the obligations under Article 
VIII of the IMF Articles of Agreement by the Israeli authorities. 
ISSN 0254-1475 
COM(94) 229 final 
DOCUMENTS 
EN 09 il 
Catalogue number : CB-CO-94-242-EN-C 
ISBN 92-77-69567-6 
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