REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL ON THE IMPLEMENTATION OF MACRO-FINANCIAL ASSISTANCE TO THIRD COUNTRIES IN 2001

List of abbreviations

CAMEL // Capital, assets, management, earnings, liquidity (parameters used in international system for rating banks)

CBA // Currency Board Arrangement

CEECs // Central and East European Countries

CPI // Consumer Price Index

DEM // German Mark

EC // European Community

EFF // Extended Fund Facility

EIB // European Investment Bank

ESAF // Enhanced Structural Adjustment Facility

EU // European Union

EUR // Euro

FDI // Foreign Direct Investment

FESAL // Financial and Enterprise Structural Adjustment Loan

FRY // Federal Republic of Yugoslavia

FYROM // Former Yugoslav Republic of Macedonia

GDP // Gross Domestic Product

IFIs // International Financial Institutions

IMF // International Monetary Fund

MFA // Macro-Financial Assistance

NIS // New Independent States

PRGF // Poverty Reduction and Growth Facility (formally ESAF)

SAA // Stabilisation and Association Agreement

SAF // Structural Adjustment Facility

SBA // Stand-By Arrangement

USD // Dollar of the United States of America

VAT // Value Added Tax

WTO // World Trade Organisation

TABLE OF CONTENTS

I. INTRODUCTION

II. OVERVIEW

1. Background

2. Macro-financial assistance in 2001

a) New decisions

b) Disbursements

c) Repayments and undisbursed operations

3. Trends and tendencies in macro-financial assistance

4. Burden-sharing

III. ALBANIA

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macro-financial assistance

IV. ARMENIA

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of exceptional financial assistance

V. BOSNIA AND HERZEGOVINA

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macro-financial assistance

VI. FEDERAL REPUBLIC OF YUGOSLAVIA (Kosovo)

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of exceptional financial assistance

VII. FEDERAL REPUBLIC OF YUGOSLAVIA (Serbia And Montenegro)

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macrofinancial assistance

VIII. THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macro-financial assistance

IX. GEORGIA

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of exceptional financial assistance

X. MOLDOVA

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macro-financial assistance

XI. ROMANIA

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macro-financial assistance

XII. TAJIKISTAN

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macro-financial assistance

XIII. UKRAINE

1. Executive summary

2. Macroeconomic performance

3. Structural reforms

4. Implementation of macro-financial assistance

I. INTRODUCTION

This report assesses the economic situation, the progress of reforms and the prospects of the countries that received macro-financial assistance in 2001, with particular reference to the implementation of the conditions attached to it.

Chapter II provides an overview of the EC macroeconomic assistance to third countries, with an historical background, a summary of the operations in 2001, and an analysis of the burden-sharing among the international donor community.

The following chapters discuss relevant aspects of the transition process in the countries for which either new macro-financial assistance operations have been decided by the Council or disbursements under previously decided operations have been made in 2000.

This report is submitted in accordance with the Council Decisions regarding Community macro-financial or exceptional financial assistance to third countries and follows on from the reports presented in previous years [1].

[1] See the following Communications from the Commission to the Council and the European Parliament with the title 'Report on the implementation of macro-financial assistance to third countries':

The complete list of macro-financial assistance operations decided by the Council with the corresponding disbursements up to the end of 2001 appears in Annex 1. Annex 2 summarises the macro-financial assistance provided by bilateral and multilateral donors to the countries that received EC macro-financial assistance. Finally, selected macroeconomic indicators are summarised in Annex 3.

II. OVERVIEW

1. Background

MFA supports the political and economic reform efforts of the beneficiary countries and is implemented in association with support programmes from the IMF and the World Bank. It has continued to incorporate a set of principles which underline the exceptional character of this assistance, its complementarity to financing from the IFIs and its macroeconomic conditionality. In particular, Community MFA has supported efforts by recipient countries to bring about economic reforms and structural changes. In close co-ordination with the IMF and the World Bank, it has promoted policies that are tailored to specific country needs with the overall objective of stabilising the financial situation and establishing market-oriented economies. The Commission implements this type of assistance in consultation with the Economic and Financial Committee.

2. Macro-financial assistance in 2001

a) New decisions

The years 1999 and 2000 had already been years of enhanced MFA to the Balkan countries, when, as a result of increased balance-of-payments difficulties and of the Kosovo crisis, seven operations for a maximum amount of EUR 515 million had been decided by the Council for Romania, Bulgaria, Albania, Bosnia and Herzegovina, the former Yugoslav Republic of Macedonia (FYROM), -Kosovo and Montenegro. In 2001, this increase in assistance to the Balkan region was confirmed by a substantial assistance package to the Federal Republic of Yugoslavia (Serbia and Montenegro). The Council decided in July 2001 to provide EUR 300 million in total of which a EUR 225 million loan and grants of EUR 75 million following democratic changes in this country. In December 2001, The Council approved a revision of this Decision by increasing the overall amount of this assistance to up to EUR 345 million of which EUR 120 million for the grant component. In June, further grant assistance to Kosovo was decided in an amount of EUR 30 million. This was followed in December with a EUR 18 million grant package to the Former Yugoslav Republic of Macedonia (FYROM).

b) Disbursements

Disbursements of macro-financial assistance amounted to a total of EUR 392 million in 2001, excluding grants of EUR 5.5 million for Armenia and of EUR 40 million for the Federal Republic of Yugoslavia (Serbia and Montenegro) disbursed on the basis of procedures initiated in 2001 but adopted in January 2002. The disbursements consisted of EUR 15 million for the Federal Republic of Yugoslavia (Kosovo), EUR 260 million for the Federal Republic of Yugoslavia (Serbia and Montenegro), EUR 15 million for Bosnia, EUR 22 million for the former Yugoslav Republic of Macedonia and EUR 6 million for Georgia. In March 2001 Tajikistan settled its remaining arrears of EUR 78.8 million towards the Community. It subsequently benefited from a new EUR 95 million assistance package consisting of a EUR 60 million loan and of grants to be disbursed over a five year period. Out of this assistance package adopted in March 2000, a grant amount of EUR 14 million and a loan of EUR 60 million were disbursed in 2001.

Out of the EUR 392 million disbursed, EUR 95 million took the form of grants. These were for the former Yugoslav Republic of Macedonia (EUR 10 million), the Federal Republic of Yugoslavia (Kosovo) (EUR 15 million), Bosnia (EUR 15 million), the Federal Republic of Yugoslavia (Serbia and Montenegro) (EUR 35 million), Georgia (EUR 6 million) and Tajikistan (EUR 14 million). The rest of the assistance took the form of loans : for the Former Yugoslav Republic of Macedonia, (EUR 12 million), for the Federal Republic of Yugoslavia (Serbia and Montenegro) (EUR 225 million), and for Tajikistan (EUR 60 million).

c) Repayments and undisbursed operations

Some MFA operations decided in the first half of the 1990s have not been fully paid out as initially foreseen. This has been the result of either improved external financial conditions (Hungary, Baltics, Slovakia, Algeria), or of a difficult political climate (Belarus). In these cases, the disbursement of the remaining tranches is not programmed anymore. For more recently adopted operations, implementation, in some cases, has been delayed because of the slowing-down in the reform process (Romania, Georgia). In the case of Albania, Moldova and Ukraine, evolving circumstances have led the Commission to reconsidering the terms of the existing assistance operations. These might be reconsidered or replaced by new revised assistance packages, possibly in the course of the year 2002. The last column of Annex 1 provides details concerning the undisbursed amounts.

3. Trends and tendencies in macro-financial assistance

The Community's macro-financial assistance is intended to support macroeconomic stabilisation of the beneficiary countries and ease their balance of payments difficulties. It plays also a very useful role in promoting structural reform.. Over the years, the number of countries to which it was appropriate for the Community to extend such support expanded, as a growing number of countries neighbouring the EU faced balance of payments difficulties and committed themselves to rigorous programmes of economic reform. This led to a change in the geographic balance of assistance from the early years, when most beneficiary countries were countries in Central and Eastern Europe. As a result of the conflicts in the Western Balkans, in particular the Kosovo conflict of 1999 and of the political changes in the Federal Republic of Yugoslavia (Serbia and Montenegro), a clear tendency for a relative increase of MFA to the countries of the Balkans developed through the 1999-2001 Council Decisions.

Out of the three MFA decisions taken in 2001, two were for traditional balance of payment assistance operations, while the third one only was designed to support the budget of the beneficiary entity. This budget support operation was decided in favour of Kosovo, which could not benefit from an IMF-supported economic programme. A particularity of the decisions of the 2000-2001 period was the substantial share of grant support in the total amount decided : 43 % instead of 6 % over the 1990-1999 period. The new grant/loan proportions of the assistance packages reflects the assessment made by the EU bodies of the relative degree of poverty of the recipient countries and of their limited debt servicing capacity. As observed already in 1999 and 2000, MFA is aimed not only at promoting macroeconomic stabilisation and the balance of payments, but also plays a very useful role in supporting the government's programme of structural reform. Consistently, MFA has been effectively combined with assistance from the Phare/Ispa, Tacis or Obnova/Cards programmes with a view to strengthening the institutional capacity that was essential to the success of the structural reform process.

Tables 1 and 2, and their accompanying Graphs 1a and 2a underline the exceptional character of the EC MFA. The highest volumes of MFA operations were decided and disbursed in the years immediately after the changes in the political and economic systems of the countries of Central and Eastern Europe. Since then, the fluctuations in the amounts of MFA reflect decisions taken on a case-by-case basis after an assessment of the macro-economic situation and financing needs of the potential beneficiary countries. Graph 1a for operations decided over the whole period from 1990 to 2001 (totalling up to EUR 5.8 billion) and Graph 2a for actual amounts disbursed (totalling up to EUR 4.7 billion) show the important concentration of the assistance in the CEECs that are candidates for EU accession (around 57% of total macro-financial assistance over the last decade). However, macro-financial assistance to these countries was progressively phased out in parallel with their progress in macroeconomic adjustment and reform. More recently, macro-financial assistance has been mainly provided to the Western Balkans (operations in 1999, 2000 and 2001) and some low income NIS. The relatively low amounts for the Mediterranean countries (14% of the overall amounts authorised, but no new authorisation since 1996) should be considered against the background of other forms of macroeconomic support made available to these countries (notably the MEDA Structural Adjustment Facilities).

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4. Burden-sharing

In the context of the donor co-ordination process in support of CEECs and the Western Balkans, the European Commission in liaison with the World Bank has organised pledging conferences where the needs for external financing are assessed and potential contributions from the IFIs and bilateral donors -including the EC- are agreed in principle. A similar approach has been followed for other potential beneficiary countries through Consultative Group meetings convened at the initiative of the World Bank.

The resources provided by various donors to support the residual external financing needs of the countries that receive EC MFA are summarised in Annex 2. Details by recipient country for the year 2001 are provided in Annex 2.1.

Since the inception of MFA, the absolute amounts committed by the EC have fluctuated substantially, in parallel with the volume of financial support provided by the international community (see Annex 2 and similar tables in previous MFA reports).

Initially, Community assistance was substantial in comparison with funding provided by IFIs. The Community indeed played a key role, both as a major provider of these funds and as the co-ordinator of bilateral assistance for the CEECs through the G-24 process. However, as the IFIs were progressively able to mobilise more resources through new instruments, their share in the financing packages rose substantially until 1999..

At the same time, contributions from external creditors, both public and private, were mobilised in the form of debt-relief and debt-reduction operations which were particularly important in 1991, 1994, 1995 and 2001. Among the countries receiving EC MFA, those concerned by these debt-relief and similar operations were Algeria in 1991 and 1994; Bulgaria in 1991, 1994 and 1997; Moldova in 1996; Ukraine in 1994, 1995 and 1999, and the former Yugoslav Republic of Macedonia, Bosnia and Herzegovina and Albania in 1999. In 2000, no debt relief took place for any country receiving EC MFA. In 2001, the Federal Republic of Yugoslavia (Serbia and Montenegro) benefited from a substantial debt relief arrangement agreed in the context of the Paris Club.

III. ALBANIA

1. Executive summary

Under the 3-year IMF programme adopted in May 1998, the Albanian authorities managed to make further progress in macroeconomic stabilisation: GDP growth for 2001 reached 6.5%, a figure slightly below the average growth rate of 7-8% registered in the three previous years, the fiscal deficit was further reduced, the current account deficit slightly deteriorated partly because of strong imports of investment goods, the exchange rate of the Lek remained strong against the euro while slightly depreciating against the dollar, and annual inflation was maintained at a low level (some 3.5%).

On the structural reform side, some progress was registered. In the financial sector, further steps were taken for the privatisation of the remaining state-owned bank, which is expected to be privatised in 2002. A second GSM license was attributed in early 2001. Progress with the restructuring of the power sector is in line with the action plan agreed in December 2000. Significant progress was also registered in the fiscal area with the adoption of the second Medium Term Expenditure Framework covering the 2002-2004 period.

The macro-financial assistance of up to EUR 20 million decided by the Council in April 1999 was not implemented because of the reticence of the Albanian authorities to increase non-concessional borrowing under a relatively comfortable Net International Reserve (NIR) position. As a result, this assistance has now been deprogrammed.

// Summary Status of Economic Reform

// 1. Price liberalisation

Prices mostly market-determined, with the exception of a few selected public services.

// 2. Trade liberalisation

No quantitative restrictions on imports. Few export bans remaining. Four different levels of tariff rates (0, 2, 10 and 15%). Member of WTO since September 2000.

// 3. Exchange regime

Since July 1992 free floating exchange rate. Exchange system largely free of restrictions on current account transactions.

// 4. Foreign direct investment

Liberal legislation. No restriction on profit repatriation. Although the sale of land to foreigners is permitted and despite progress in land registration, the land market is not yet functioning properly.

// 5. Monetary policy

Central bank monetary policy entirely based on the use of indirect instruments, following the removal of minimum short-term deposit rates in July 2000. Treasury bill auctions (3, 6, 12 months).

// 6. Public finances

VAT introduced in July 1996 and reformed in October 1997. Update in June 2001, for the period 2002-2004, of the Medium Term Expenditure Framework (MTEF) designed in December 2000.

// 7. Privatisation and enterprise restructuring

Privatisation of arable land largely completed. 1997 SME's privatisation programme completed. First large state-owned strategic enterprise (AMC) privatised in 2000. Stock exchange set up in March 1996.

// 8. Financial sector reform

Two-tier banking system dominated by the remaining large state-owned bank, the Savings Bank, to be privatised in 2002.

//

2. Macroeconomic performance

Since 1998, the Albanian authorities have implemented a comprehensive medium-term macroeconomic and structural adjustment programme supported by the IMF under a Poverty Reduction and Growth Facility (PRGF, formerly ESAF). The successful start of recovery in 1998 was maintained in 1999 and 2000 with GDP growth of respectively 7.3 and 7.7%. Annual inflation as of end-2000 remained under control, at 4.5%, the domestically financed budget deficit was further reduced, and the current account deficit decreased to 7% of GDP.

Owing to the weak agricultural growth and to the deteriorating electricity situation, real GDP growth in 2001 slowed down to 6.5%, from an average of 7-8% in the previous three years. Transport and services mainly contributed to this growth. Albania's growth performance also had a positive impact on the unemployment rate, which declined from about 17% in December 2000 to about 14.5% in December 2001 - possibly also because of increased controls on enterprises and the grey economy. A relatively restrictive monetary policy, coupled with significant increases in productivity, contributed to keeping inflation under control. In spite of inflationary pressures caused by the crisis in the neighbouring FYRoM, as well as by election-related public expenditure, inflation was limited to 3.5% in December (year-on-year).

Taking into account the amendments to the 2001 budget resulting from the energy crisis and involving additional subsidies for electricity imports, fiscal performance in 2001 has been broadly on track with expectations, however with lower than projected revenue and expenditure. The overall deficit is expected to have reached around 9% of GDP, in line with the 2000 figure. Foreign financing of the deficit, which predominantly took the form of grants or concessional borrowing, accounted for about 4% of GDP, domestic financing for about 3%, privatisation receipts accounting for the remaining 2%.

As usual since the beginning of the transition, strong inflows of remittances from Albanians living abroad - estimated at about USD 470 million in 2001 - partly compensated for the officially recorded trade deficit, which is however reported to have increased because of important imports of investment machinery and better customs control. Consequently, the current account balance is expected to have slightly deteriorated (7.4% of GDP, compared to 7% in 2000). Foreign direct investment accelerated in 2001, which contributed to a new increase in foreign exchange reserves (USD 737 million or 4.7 months of imports as of end-2001, compared to USD 608 million or 4.3 months of imports as of end-2000). The combination of low inflation and a fairly comfortable level of foreign exchange reserves contributed to the stability of the exchange rate of the national currency: over the last couple of years, the Lek has only slightly depreciated against the dollar, while remaining roughly stable vis-à-vis the euro. At the end of 2001, foreign debt, including arrears, reached a level of USD 1.19 billion, corresponding to about 29% of GDP, which is quite low compared to some other Western Balkan countries, and is expected to stabilise at this level in the years to come.

3. Structural reforms

Further progress was achieved in 2001 in enterprise privatisation and restructuring. Following the sale in July 2000 of the mobile phone company AMC, a second GSM license was attributed in August 2001 to a British-Greek consortium (thus contributing to FDI). In May 2001, the Albanian Parliament approved the law for the privatisation of the fixed-line telecom operator, Albtelekom, which is expected to be completed in late 2002. As of September 2001, progress with the implementation of the restructuring of the power sector, including the electricity company KESH, was broadly in line with the action plan agreed in December 2000. Steps were also made in the privatisation of the oil company Servcom.

The privatisation of the National Commercial Bank in October 2000 created the preconditions for the privatisation of the remaining state-owned - and largest - bank in the country, the Savings Bank (SB). Following the adoption by Parliament of the necessary privatisation law and other preparatory steps, the opening of the international tender for its privatisation was announced in June 2001. However, following the 11 September events and continuing unrest in the former Yugoslav Republic of Macedonia, the privatisation process has been delayed. The revised timetable includes a short list selection of interested banks by the end of March 2002 and the selection of the buyer by the end of June. Meanwhile, efforts have been made to reduce the SB's dominant position in the market, by transferring 70 pension payment offices to Albapost, and by contracting SB's fiscal functions in Elbasan district, via auctions, to the German FEFAD Bank.

Concerning trade liberalisation, there are no quantitative restrictions on imports and only very few remaining on exports (skins and hides and scrap metals, and some wood products). As from January 2001, the maximum tariff rate on imports has been reduced to 15%, which represents a significant reduction from that prevailing in 1999 (20%) and 2000 (18%).

Some steps have been carried out in order to improving the Albanian business environment and investment climate. A Bankruptcy Law, consistent with the Law on Securing Charges, has been adopted in 2001, as well as a Law on Deposit Insurance. The registry for movable property is now operational. Efforts are being made to further improve the legal framework and to stimulate domestic and foreign investments. The setting up of an agency that will provide "one-stop" facilities for investors and a credit information point is planned for 2002. The law for the execution of court decisions was approved in January 2001 and a law on mediation of business disputes was expected to be approved before the end of the year 2001. However, despite these initiatives, the current deficiencies of the Albanian judiciary and business-related administrations, as well as repeated corruption cases, prevent a serious boost of investments. Key legislation such as the commercial law remains to be improved in order to facilitate adequate implementation and enforcement.

In the fiscal area, the Medium Term Expenditure Framework (MTEF), designed for the first time in 2000, was updated and improved in June 2001 for the 2002-2004 period within the framework of the World Bank-sponsored Growth Poverty Reduction Strategy (GPRS). The MTEF and the GPRS provide a strong framework for the preparation of the 2002 budget with a clear prioritisation of expenditure.

4. Implementation of macro-financial assistance

In the context of the 3-year PRGF-supported programme approved by the IMF in May 1998, the Council decided on 22 April 1999 to provide to Albania a macro-financial assistance facility of up to EUR 20 million. Contrary to the previous two macro-financial assistance operations (EUR 70 million grant decided in 1992 and EUR 35 million grant decided in 1994), this assistance would take the form of a loan.

However, in 1999 and 2000, the Community also supported Albania's short- and medium-term adjustment and reform programme with targeted grant support to the budget: EUR 14.5 million through the PHARE Special Assistance and EUR 5 million under the EC Food Security Programmes. To help the country to cope with the costs linked to the presence of refugees during the Kosovo crisis, the Commission also provided to Albania exceptional grant budgetary support of some EUR 33 million.

In this context, and also in the light of the country's favourable hard currency reserves position, the Albanian authorities have indicated that they did not require the release of the Community macro-financial assistance in the form of a loan. As a result, the Commission has now deprogrammed this assistance operation.

IV. ARMENIA

1. Executive summary

The Armenian economy grew at a record high rate in 2001. Real GDP growth was 9.6 % (6.0 % in 2000). Growth was driven by agriculture, construction and services. Exports were up 14 % while imports remained unchanged from previous year. The current account deficit declined somewhat to about 11 % of GDP (14.5 % in 2000). Budget revenues increased as tax collection improved, but the tax/GDP ratio declined

The Parliament approved in July 2001 a list of over 900 enterprises to be privatised over the next three years, including mining, metallurgical and energy assets. Lack of interest from foreign investors in a difficult investment climate has however delayed bidding and negotiations.

The IMF Board approved a three-year arrangement for Armenia under the Poverty Reduction and Growth Facility in May 2001. Of the total PRGF loan amount of about USD 87 million, USD 13 million was disbursed in 2001.

The Commission concluded in June 2001 that Armenia had made substantial progress in satisfying the conditions for the disbursement of the grant tranche scheduled for 2001. The grant disbursement was made in February 2002. // Summary Status of Economic Reform

1. // 1. Price liberalisation

No administered prices exist outside the utilities sector.

1. // 2. Trade liberalisation

Liberal trade policy. Simple and relatively open import regime with a low tariff structure. No quantitative restrictions. Negotiations on access to the WTO continued in 2001 (agricultural protection remains unresolved).

1. // 3. Exchange regime

Floating exchange rate. Limited official intervention. Access to foreign exchange unrestricted. Interbank market dominant for foreign exchange.

1. // 4. Foreign direct investment

Liberal policy towards foreign direct investment, absence of restrictions on repatriation of profits and capital.

1. // Monetary policy

Low inflation environment maintained through cautious monetary policies conducted by the Central Bank.

1. // 5. Public finances

Budget revenue estimated at around 17 % of GDP in 2001; total expenditure estimated at about 22 % of GDP.

1. // 6. Privatisation and enterprise restructuring

New privatisation programme approved in Parliament. The privatisation process has however slowed down due to lack of investor interest in a difficult business climate. New attempts to bring private management to the power distribution companies after the international tender failed.

1. // 7. Financial sector reform

The fully state-owned Savings Bank has been sold to local investors in 2001. Minimum capital requirement for existing banks increased in 2001 and further increases scheduled for coming years.

1. //

2. Macroeconomic performance

Armenia has made progress in macroeconomic policies, but continues to run a high current account deficit and relies on transfers and remittances from the Armenian diaspora to finance this. The Armenian economy grows at record high speed: real GDP grew by 9.6 % in 2001 (the highest rate since independence). Because it is fairly isolated from world markets, the current economic slowdown has not affected Armenia. Growth is supported by both exports and domestic spending. There was a 13 % rise in retail sales in 2001. Exports rose by 14 % while imports remained virtually unchanged from the previous year. Continued growth in exports is important since the lack of trade relations has hindered export expansion to regional markets (due to regional isolation in relation to the unsolved Nagorno Karabakh conflict). The current account deficit (including official transfers) declined in 2001 somewhat to 11 % of GDP (from 14 % of GDP in 2000).

During 2001, budget revenues increased as tax collection improved, but the positive development was not maintained throughout the year and there were problems in budget implementation towards the end of 2001. Revenue increases allowed the government to reduce pension arrears. Nevertheless, the tax/GDP ratio declined to 14.3 % in 2001. No significant reduction in the general government deficit has been recorded in 2001, and the deficit is estimated to have remained at nearly 5 % of GDP.

Monetary policy was gradually loosened over 2001, and consumer price inflation rose from 0.4 % in 2000 to 2.9 % in 2001, which remains, however, below the projected 3.5 %. The Armenian dram was rather stable in 2001 at about 560 dram per USD. Foreign exchange reserves are still comfortable at more than 3 months of imports. External debt amounted to around USD 860 million (about 45 % of GDP) at the beginning of 2001, and there was no substantial change during 2001. Armenia has negotiated an agreement with Russia on a debt-equity swap for its USD 94 million debt. The agreement will become effective in 2002.

The IMF Board approved a three-year arrangement for Armenia under the Poverty Reduction and Growth Facility in May 2001. Of the total PRGF loan amount of about USD 87 million, USD 13 million was disbursed in 2001. Towards the end of the year Armenia encountered problems in meeting the agreed economic policy targets and further disbursements were postponed until early 2002.

3. Structural reforms

The pace of structural reforms started to recover in 2001 after a slowdown in 1999-2000. The Parliament approved in July 2001 a new privatisation programme which includes a list of over 900 enterprises to be privatised in three years. The list includes also mining, metallurgical and energy assets. At the same time, the emphasis has shifted from quick sales toward attraction of suitable strategic investors. The privatisation process has not been proceeding as expected, however. Of the 14 larger companies which were originally targeted for privatisation in 2001, seven were sold. A difficult investment and business climate has dampened interest from abroad. For instance, the international tenders to privatise four electricity distribution companies failed to attract bids in 2001. As an alternative, it has been decided to merge the four networks into one, and the government has started negotiations on leasing the distributors to a foreign operator for a three-year period. Privatisation of power generation assets is also under preparation.

Minimum capital requirements for existing banks have been increased to accelerate consolidation in the very fragmented banking sector. The last fully state-owned bank, the Savings Bank, was sold to a group of Armenian investors in 2001.

There has been progress in bringing competition policies in line with EU rules. A new law on competition policy has been enacted and an independent Competition Commission has been established. Enforcement of bankruptcy legislation still remains ineffective, however.

Also a new financial disclosure law for all highly placed public officials has been enacted. A government commission for anti-corruption policies has been created, but adoption and implementation of new measures has progressed slowly.

A new tax code was enacted in December 2000 to replace progressive corporate taxation with a flat rate of 20 % for large businesses. Measures to simplify the tax code for small businesses have also been taken.

The Government has declared the development of information technologies as its main priority in fostering the economy and creating new jobs. Armenia has specialists and expertise in the sector and it seeks to limit the brain drain which has become a serious problem.

4. Implementation of exceptional financial assistance

Armenia has benefited from a European Community assistance package which consists of a loan of EUR 28 million (disbursed in 1998) and a total grant amount of EUR 30 million (to be disbursed over the period 1998-2004). The structural conditionality for the 2001 grant tranche included i.a. conditions on improvement in tax collection rates, strengthening of prudential regulation in the banking sector, adoption of a new land code, clearing of arrears on salaries and pensions, clearing of arrears to energy suppliers and preparation of a vade-mecum for foreign investors. A Commission staff mission concluded in June 2001 that Armenia had made substantial progress in satisfying the macroeconomic and structural conditions for the disbursement of the 2001 grant tranche which amounts to EUR 5.5 million. The grant disbursement was made in 2002 on the basis of the procedure initiated in 2001, after Armenia's reduction of its net debtor position towards the Community by EUR 7 million as agreed between the Commission and the Armenian authorities.

V. BOSNIA AND HERZEGOVINA

1. Executive summary

Under the IMF-supported Stand-By Arrangement (SBA), approved in May 1998, Bosnia and Herzegovina (BiH) has made significant progress towards macroeconomic stability thanks to adherence to the strict rules under the currency board arrangement as well as fiscal restraint. In 2001 growth remained sustained, although it was revised downwards to 5-6%, from an initially estimated 8%, and inflation subdued (at about 4.5% in 2001). The high current account deficit is estimated to have declined further in 2001, to 20.8% of GDP (22.2% in 2000). The IMF completed the sixth and final seventh reviews under the SBA on 10 May 2001 and a new arrangement is expected to be agreed in early 2002.

In the area of structural reforms, marked progress has been made in 2001 in small-scale privatisation, public expenditure management and reform, customs administration reform and recently also large-scale privatisation. However, progress was slower in the areas of tax harmonisation, privatisation of state-owned banks, and establishing a simplified investment environment.

Given the satisfactory progress with regard to structural conditions attached to Community macro-financial assistance, the Commission disbursed the third and final grant tranche amounting to EUR 15 million at the end of 2001. // Summary Status of Economic Reform

1. // 1. Price liberalisation

Most prices have been liberalised with the exception of a few selected public services.

1. // 2. Trade liberalisation

The Free Trade Agreement (FTA) with Croatia became effective on January 1, 2001, with tariffs on goods originating in BiH being reduced by 30 % and up to 100 % from 2004 onward. Similar FTAs are being negotiated with FYROM, Slovenia and FRY. Accession to the WTO is moving ahead and is expected in the first half of 2002.

1. // 3. Exchange regime

The common currency, KM, is pegged to the DM/Euro at parity under the currency board arrangement since June 1998 and no revision of the parity in connection to the switchover to the Euro was foreseen.

1. // 4. Foreign direct investment

Uncertain environment resulting from perceived high risks and non-transparent policies. The Federation has adopted in November 2001 a law on foreign investment, making its legislation compatible with the 1998 State law on foreign investment policy.

1. // 5. Monetary policy

The Central Bank of BiH is responsible for operating the Currency Board Arrangement. The CBBH and other banks are prohibited from lending money to the government.

1. // 6. Public finances

Bloated public sector wage bills, subsidies, and unsustainable social security schemes. State budget not secured by own resources and contingent upon entities contributions. Progress has been achieved though at the institutional level. Tax harmonisation between entities not yet attained.

1. // 7. Privatisation and enterprise restructuring

While small-scale privatisation has advanced well in both Entities recently, the process of large-scale enterprise privatisation has been slow and has gained new momentum only recently thanks to external technical assistance for tender procedures.

1. // 8. Financial sector reform

The regulatory framework for banking has been laid down in both Entities, but the process of privatisation or liquidation of state banks has been slower than expected. Reform of the payments system is well advanced with the official closure of the Payments Bureaux, the transfer of their functions to the banking sector and the establishment of a central clearing house.

2. Macroeconomic performance

General elections took place in November 2000; however, only after protracted negotiations and the intervention of the OHR could governments be formed in both Entities and the State. They were formed in January 2001 in Republika Srpska (RS), February in the State and March in the federation of BiH (FBiH). This delayed economic reform and led to an extended legislative paralysis. In the second half of the year, the new governments regained momentum in their progress with reforms.

Macroeconomic data for 2001 indicate that GDP growth continued to decelerate, and the authorities expect a growth rate of around 5-6% for the year 2001 as a whole, compared to higher rates in previous years and an initial 8% estimate. Tentative information points to some recovery of agricultural production, from the decline in 2000 which was mostly due to a severe drought. Unemployment is estimated at about 40% of the labour force, a rate which is particularly high if compared with the average rate in the Western Balkan region (17%) or in candidate countries (12%).

Inflation remains subdued (estimated at about 4.5% in 2001) and the exchange rate of the Konvertible Marka (KM) stable, supported by a strict adherence to the rules of the currency board introduced in mid-1998. Maintaining its credibility is the main monetary objective of the Central Bank. The KM was pegged on a 1:1 basis to the Deutsche Mark/Euro, and the monetary authorities have ruled out any revision of the parity in connection to the switchover to the euro. On the fiscal side, general government expenditure remained very high and was estimated at about 44% of GDP in 2001. Bloated public sector wage bills, subsidies, and unsustainable social security schemes are a cause for concern; larger than expected deficits as a result of increased spending on wages and pensions have forced the State to take action towards the end of the year to bring current expenditure into line with available resources.

The trend of export recovery initiated in 2000 (partly due to a reopening of the Yugoslav market), combined with a slight increase of imports (mainly due to reductions in donor finance for reconstruction) translated into an almost constant trade deficit of USD 1.6 billion. The current account deficit (excluding transfers) declined further in 2001. But with 20.8% of GDP (after 22.2% in 2000), it still is very high. Foreign debt remains at high levels (about 61% of GDP in 2001), partly as a result of a substantial debt burden inherited from the former Yugoslavia. Debt service in percentage of export of goods is relatively low, though, reflecting the concessional nature of much of the debt and favourable debt rescheduling. Net foreign direct investment (FDI) per capita increased from USD 35 in 2000 to USD 38 in 2001 (projected), but remains one of the lowest of the region. Little progress has in fact been achieved in improving the legislative environment for FDI, which remains difficult and non-transparent, with differing rules across Entities.

3. Structural reforms

Progress has been made in 2001 with regard to public expenditure management and reform. At the State level, work is already under way to strengthen budgetary control of State functions in a Ministry of Treasury set up in October 2000. At the Entity level, Treasury departments have been established in the course of the year in the Finance Ministries of both Entities, and the creation of a Single Treasury Account is operational since 1st of January 2002. All government payment orders will pass through this account, hence ensuring greater fiscal transparency and control.

In the area of customs and tax reforms, both Entities have now adopted a Law on Tax Administration. While some steps in harmonising tax rates have been taken, especially for excise and sales tax rates, full harmonisation is not yet attained. As far as the reorganisation programme of the tax administration is concerned, much progress has been achieved in 2001 in the Federation, where the establishment of control and investigation units, as well as of a debt management service is progressing well. The RS has speeded up this process only recently, and adopted the relevant Law in October 2001. Discussions on the introduction of VAT are only in a preliminary stage, and raise a number of issues related to the difficult co-operation between the two Entities.

Small-scale enterprise privatisation has advanced well in both Entities; the Federation has privatised up to now 192 small-scale enterprises, while in the RS 169 have been sold. The deadline for the sale of the remaining public small enterprises has been extended and has now been set for 31 March 2003. For large-scale privatisation, progress has been slower, although the process was speeded up recently. In the Federation, 34 companies, out of 157 offered, were successfully privatised. In the RS, where it has been particularly difficult to attract foreign bidders, only three strategic companies, out of the original list of 86, have been privatised to date, while contract negotiations are ongoing for a fourth company. The impact of privatisation on corporate governance remains uneven and often delayed, in so far as citizens or the privatisation investment funds are not always in a position to assess the viability of the enterprises or impose industrial restructuring.

The payment bureaux were closed at the beginning of January 2001 and their functions transferred to the banking sector. Substantial progress has also been achieved in banking supervision and prudential regulations (e.g. through the increase of minimum capital requirements). On the other hand, privatisation of state-owned banks progressed at a slower pace than envisaged, in both Entities: no bank has been privatised in the Federation, even though two banks are in the final stage of negotiations, while only three banks have been sold in the RS. By the end of 2001, a draft law on deposit insurance was prepared, which envisages the creation of a State-level bank-deposit insurance agency. It is expected to cover depositors' assets up to KM 5,000 in member banks. At present separate agencies exists in each Entity, although in the RS no funds have been reserved to cover relevant interventions.

4. Implementation of macro-financial assistance

In May 1998, the authorities of BiH concluded a Stand-By Arrangement (SBA) with the IMF. In May 1999, the Council decided to provide BiH with a package of Community macro-financial assistance comprising a loan facility of up to EUR 20 million and a grant facility of up to EUR 40 million (Decision 1999/325/EC). Following the completion of the first review under the IMF programme and the full clearance by BiH of its outstanding obligations to the Community and the EIB, the Commission disbursed in December 1999 a first tranche totalling EUR 25 million (EUR 15 million grant and a EUR 10 million loan). Following satisfactory progress under the IMF programme, including the completion of the fourth and fifth reviews, and the satisfactory fulfilment of the specific conditions attached to the Community assistance (relating to structural reform), the second tranche, amounting to EUR 20 million, was disbursed at the end of 2000. Out of this amount, EUR 2 million of the EUR 10 million grant element was made available to the State budget, while the remainder was made available to the Entity budgets.

Following some delays in policy implementation, which required three extensions of the SBA (in May 1999, March 2000 and December 2000), the IMF completed its sixth and final seventh review and approved the disbursement of USD 18 million (SDR 14 million) in May 2001. Negotiations are still under way with the BiH authorities on a new SBA, which is expected to be signed in the early months of 2002.

The disbursement of the third tranche of EUR 15 million (all grant) had been linked to continued progress under the IMF programme as well as to a set of structural reform criteria including i.a. in the area of public expenditure management, customs and tax, privatisation and banking reforms. In mid-2001, a first review was carried out by Commission staff which acknowledged progress in several areas but encouraged the authorities to make further progress in other key areas, such as public expenditure management and reform or FDI legislation. Following a second review in November, and the broad fulfilment of structural conditions by the BiH authorities, the third and final tranche of Community assistance was disbursed at the end of 2001. Out of the total amount, EUR 2.5 million have been made available directly to the State budget, while the remainder was made available to the Entity budgets.

VI. FEDERAL REPUBLIC OF YUGOSLAVIA (Kosovo)

1. Executive summary

Economic activity in Kosovo has resumed with considerable speed after the conflict and living conditions continued to improve: growth of real GDP is estimated to have been in the order of 10% in 2001, albeit coming from a low level and driven by donor supported reconstruction. GDP inflation is estimated at 13%. However, manufacturing and export activities remain subdued and unemployment is high.

UNMIK, and particularly its EU-led Pillar IV, responsible for economic reconstruction and development, has further progressed in important economic areas. It has enhanced unexpectedly well revenue collection and tax compliance. The number of banks as well as bank deposits and lending have developed favourably. In the absence of an acknowledged privatisation body, UNMIK also carried out commercialisation tenders for state-owned enterprises so as to pave the ground for investment.

In continuation of its support, the Council decided in June 2001, following a Commission proposal, to provide further exceptional Community financial assistance to Kosovo of up to EUR 30 million in the form of a grant (2001/511/EC). The disbursement of the first tranche took place in September upon the signature of a Memorandum of Understanding between UNMIK and the Community. // Summary Status of Economic Reform

// 1. Price liberalisation

Prices are liberalised with the exception of a few public services.

// 2. Trade liberalisation

UNMIK applies an amended FRY customs code, charging a 10% customs rate, varying excise duties, and sales tax (15%), replaced by the VAT in July 2001, on imported goods. It does not charge customs on goods originating in the rest of FRY. UNMIK has maintained the preferential trading arrangements of FRY with the former Yugoslav Republic of Macedonia.

// 3. Exchange regime

The use of the euro/D-Mark (and other currencies) has been legalised, albeit the Yugoslav Dinar remains the legal tender.

// 4. Foreign direct investment

The establishment of the commercial law framework has advanced. However, the business environment remains unfavourable resulting from political situation and legal uncertainties.

// 5. Monetary policy

Given its status, Kosovo does not have a Central Bank nor a monetary policy. The Banking and Payments Authority of Kosovo (BPK) exercises a number of functions usually attributed to a central bank including the preparation of the changeover to the euro from January 2002 onwards.

// 6. Public finances

Domestic revenues exceeded original estimates in 2001. Further expansion of taxes and measures to enhance revenue collection are planned. The control of the public wage bill remains a challenge. For the time being, there is no comprehensive social protection system.

// 7. Privatisation and enterprise restructuring

Privatisation of public enterprises is hampered by legal uncertainties. UNMIK continued to commercialise enterprises through management contracts.

// 8. Financial sector reform

Within the regulatory and supervisory framework of BPK, the number of licensed banks has increased to seven. The number of accounts and deposits are developing positively. The payments system is advancing with increasing number of non-cash transactions. Based on a regulation passed in October, a regulatory and supervisory framework for the insurance sector is being set up.

//

2. Macroeconomic performance

Economic activity has resumed with considerable speed after the conflict and living conditions continue to improve: growth of real GDP is estimated to have been in the order of 10% in 2001, albeit coming from a low level. Reconstruction is evident, agriculture is rebounding and there is a vibrant private service sector. Winery, one of the few export sectors, seems to develop positively: a production of 10 million litres is expected for 2001. The number of registered businesses as of October 2001 has increased by 44% compared to end of 2000. There are indications of a shift from trade to other economic activities including manufacturing. However, the economy continues to be characterised by the donor supported reconstruction programmes and the significant foreign presence resulting in unusually high imports and problematic imbalances in salary and taxation. Unemployment remains high (in the order of 50%). GDP inflation in 2001 is estimated at some 13%. The availability of macro-economic data remains poor: there are no official figures for GDP, GDP growth, inflation, consumption, private investment or population from the Statistical Office of Kosovo. Despite progress and considerable efforts to refine the estimates, the calculation still bear a significant level of arbitrariness due to the weak database.

The Central Fiscal Authority (CFA) managed well the implementation of the Kosovo budget 2001 although a number of budget expenditure items were revised upwards during the year from original DM 500 million to DM 566.5 million. Preliminary data suggest that actual expenditure for 2001 will turn out in the order of DM 537 million whereas domestic revenue collection performed significantly better than originally budgeted (DM 572 million compared to DM 338 million). Depending on the final outcome of the budget and including donor support for the budget, the CFA will be able to carry forward a certain accumulated cash balance, which will be needed temporarily to provide collateral for the euro conversion and for contingency purposes. The balance will allow the budget to mature, i.e. to address a number of long-term obligations and to initiate capital investment expenditure under the budget, notably for maintenance of donor investments. This is also important since donors support is expected to decrease.

According to the European Agency for Reconstruction (EAR), the provision of public services has improved but its sustainability remains a major concern of the reconstruction efforts. The public utilities, notably the energy sector, still suffer from unreliable supply and very low cost recovery. The de-facto low price provides incentives for increasing consumption (e.g. car-wash facilities, electric heater). In the area of telecommunication, the progress in the fixed line network is still limited and province-wide telecommunications largely rely on the mobile network. In the area of rail, some lines are running; a master plan on the network is being worked on including the establishment of facilities for spare parts and basic rehabilitation.

3. Structural reforms

UNMIK has progressed unexpectedly well in enhancing revenue collection and tax compliance. This is due to the opening of Tax Collection Offices at the Administrative Boundary Line (ABL) with Serbia, the successful implementation of the VAT from 1 July onwards, effective control measures and improved capacity ensuing from on-going recruitment and training.

UNMIK prepared the introduction of a two-pillar pension system comprising a pay-as-you-go-system financed from contributions (including a universal benefit scheme for those who did not contribute to the past pension system) and a mandatory fully funded system.

In 2001, the Banking and Payments Authority of Kosovo (BPK) fully licensed an additional six commercial banks thus totalling seven banks which operate 22 branch offices. So as to ensure stability and to avoid overbanking, the BPK will raise the capital requirements with effect from January 2002. The BPK is carrying out regular supervision inspections, which have not brought up any grave misconduct. In addition, BPK has granted licenses to 15 micro-finance and non-bank financial institutions, (seven in 2001), that provide credit to individuals and SMEs. The growth in deposits reflects both the growing number of banks and confidence in the system. Loan activity however is more constrained and limited to a maturity below 12 months. The lack of access to debt finance for capital investment is one of the major obstacles to the further development of productive activities. In particular, the lack of collateral for bank lending is identified as one of the major factors hampering such an access.

On 5 October 2001, UNMIK adopted the regulation on Insurance Licensing, Supervision and Regulation, which assigns the BPK with the licensing and supervising of insurance companies. Existing insurance companies are required to apply for licensing under the new regulation.

The BPK has continued to improve its payment system to offer payment services to UNMIK, the Kosovo civil administration and NGOs. According to the BPK, it currently provides UNMIK with payments services through seven branches throughout the region and makes over 80,000 individual payments monthly for public salaries and stipends. The BPK aims to restrict its services to banks; it has closed down the accounts of public enterprises. The inter-bank clearing system inaugurated in May is operating smoothly and more than doubled the monthly transactions until October compared to June.

The number of non-cash payments is increasing. Starting with some 75 non-cash transactions in July, the department of public services has paid in October some 1,300 salaries upon accounts and almost 2,900 payments in December. Until the end of the year, UNMIK was subsidising the charges linked to opening and holding an account with a bank. Some departments started to require the holding of an account as a pre-condition for recruitment.

UNMIK has closed further the missing elements in the commercial law framework. Through its regional offices, it provides business information and contacts; it organises seminars and management training. It is also carrying out substantial training of Kosovars to work in the ministry. However, UNMIK continues to suffer from the lack in political support to progress in the area of privatisation. In the absence of an acknowledged privatisation body, UNMIK also carried out commercialisation tenders and has signed, as of 15 November, 11 deals committing an investment volume of DM 108 million over the contract period. It remains a major challenge to improve the quality of the judicial system and law enforcement so as not to deter investors.

Concerning the changeover to the Euro, UNMIK follows the model of the EU area with only two months of dual circulation so as to limit money laundering. The BPK has estimated cash needs at about DM 15-20m of coins in total, compared to DM 500m for notes. A public information campaign was organised in the course of 2001. The BPK has been in contact with the ECB, Deutsche Bundesbank, Österreichische Nationalbank and the banks it holds account with (Commerzbank, Raiffeisenbank). The ECB approved a frontloading also in the case of Kosovo; commercial banks have provided for the cash shipments.

4. Implementation of exceptional financial assistance

Following the provision of a first exceptional financial assistance grant of EUR 35 million in 2000 as part of a broader Community assistance package of EUR 360 million, another grant of up to EUR 30 million has been approved in June 2001 (2001/511/EC) with a view to alleviating the financial situation in Kosovo, facilitating the establishment and continuation of essential administrative functions and supporting the development of a sound economic framework. These funds add to the EUR 320 million pledged under CARDS assistance in 2001.

A first tranche of EUR 15 million was disbursed in mid-September following the signature of a Memorandum of Understanding (MoU) between UNMIK and the Community. The release of the second tranche is subject to satisfactory compliance with economic policy conditions as laid down in the MoU. These include measures to promote the financial and private sector development, to produce macro-economic data, and, most importantly, to develop the revenue base further so as to pursue prudent budgetary policies. The funds were to be made available to UNMIK through its CFA. A first review by the Commission in November showed that considerable progress has been made in these areas.

In the course of the implementation of its exceptional financial assistance, the Commission has been maintaining close contacts with the International Financial Institutions, notably the IMF and the World Bank, both at working level as well as via the regular meetings of the Working Level Steering Group monitoring the economic and financial developments in Kosovo.

VII. FEDERAL REPUBLIC OF YUGOSLAVIA (Serbia And Montenegro)

1. Executive summary

Overall it appears that one year after the political changes occurred in the FRY in late 2000, the authorities have accomplished substantial progress toward restoring macro-economic stability, liberalising the exchange, price and trade regimes and improving market confidence. In 2001, real output grew by 5.5 %; inflation has declined considerably from 115 to 40%, the exchange rate has been kept stable while foreign exchange reserves increased substantially, and budget performance was good with a much lower than expected cash deficit before grants. However, economic difficulties persist and further important decisions on the restructuring of the FRY economy will be on the political agenda soon. They will most likely lead to the eventual closure of a number of big and non-viable enterprises and banks. At the same time the authorities will be facing the challenge of sustaining general public support for reforms.

In October 2001, the second review under the IMF stand-by arrangement that covers the period until end-March 2002 was started and successfully completed in mid-January 2002. It enabled the FRY to draw on the third tranche of USD 62.5 million out of the total amount of USD250 million.

In July, the Council decided to provide a macro-financial assistance to FRY of up to EUR 300 million. Following the clearance of all arrears of the FRY towards the European Investment Bank and the Community, the first tranche of EUR 260 million was released in October 2001. Following a satisfactory review of economic policy conditions, the second tranche of EUR 40 million was disbursed in January 2002. On 10 December 2001, the Council approved a revision of its July decision designed to increase the overall amount of this assistance to up to EUR 345 million.

// Summary Status of Economic Reform

1. // 1. Price liberalisation

Most administrative price controls have been removed with the exception of some public services where considerable price increases have been implemented.

1. // 2. Trade liberalisation

A new 2001 federal law simplified procedures, abolished most licences and quotas, reduced the number of duties and lowered the average tariff rate ; separate trade law in Montenegro with lower tariffs than on the federal level.

1. // 3. Exchange regime

Managed float regime under which the exchange rate of the Dinar has been kept stable; Montenegro introduced the Euro as the sole legal tender in November 2000.

1. // 4. Foreign Direct Investment

FDI is still relatively low, Serbian foreign investment law in preparation; Montenegro adopted a law on FDI already in 2000.

1. // 5. Monetary policy

Strict monetary policy of the National Bank of Yugoslavia; creation of base money almost exclusively on the basis of foreign exchange increases and limited credits to general government; no sovereign monetary policy in Montenegro.

1. // 6. Public finance

Comprehensive fiscal reforms, including the implementation of a major tax reform in Serbia and the preparation of a Tax Action Plan in Montenegro; initial steps to improve fiscal management; improved revenue collection and expenditure control, Treasury system being set up.

1. // 7. Privatisation and enterprise restructuring

Adoption of a new privatisation framework in Serbia in June 2001, enterprise and anti-trust law in preparation, restructuring plans for two large loss makers adopted, continuation of Mass Privatisation programme in Montenegro.

1. // 8. Financial sector reform

Progress in bank rehabilitation in Serbia, Bank Rehabilitation Agency was set up, all banks have been screened and either closed, merged or put under enhanced supervision. Four largest non-viable Serbian banks to be closed. In Montenegro, the largest bank, Montenegro Banka, was put under temporary administration.

1. //

2. Macroeconomic performance

Real GDP growth in 2001 (5.5%, incl. some 3.5% in Montenegro) was mainly driven by a strong recovery in agricultural output (20-25%) from the previous year's severe drought, and increased activity in services, including tourism in Montenegro, and transportation. However, industrial production continued to perform poorly and in Jan-Nov 2001 it was 0.6% lower than during the same period in 2000.

As a result of tight monetary policies, inflation in Serbia came down considerably from 115% at end-2000 to around 40% at end-2001, despite several major increases in electricity prices by a cumulative 120% since the start of 2001. In Montenegro, annual inflation increased slightly to 25% from 22.5%, mainly due to accelerated liberalisation of prices for electricity, municipal services, transport and milk and bread in the course of the year.

The consolidated general government accounts in the FRY recorded a cash deficit before grants of some 2.4% of GDP in 2001 (around USD 240 million), compared to the originally budgeted of 6.1% of GDP. The lower deficit was mainly due to improved tax revenue performance, but also reflected action taken to compress public spending (by 1.8% of GDP) in the light of a shortfall in foreign budgetary financing and delays in obtaining privatisation receipts in Serbia.

Following the adoption of a managed float in Serbia at the beginning of 2001, the Dinar remained broadly stable at the level fixed in October 2000 (YuD 30 per Deutsche Mark). Gross reserves of the National Bank of Yugoslavia reached around USD 1,300 million by end-January 2002 (compared to USD 605 million at the beginning of 2001), equivalent to almost 2.9 months of projected imports in 2002. In Montenegro, the unilateral adoption of the Deutsche Mark/Euro as the sole legal tender in late 2000 contributed to macro-economic stabilisation as it excludes the possibility of base money creation.

The balance of payments of the FRY recorded a widening trade deficit in 2001, which could be close to USD 2,800 million, and large inflows of remittances and service receipts. The latter helped containing the current account deficit to around USD 1,075 million before grants. Foreign Direct Investments are still low and were expected to reach USD 120 million in 2001.

A huge outstanding debt of some USD12.2 billion at end-2001, or 140% of GDP, is a major constraint on the external front. In that respect, the agreement between the Paris Club and the FRY authorities on a phased 66% reduction in the net present value of obligations towards Paris Club creditors (some USD4.5 billion) and a rescheduling of the remaining stock over 22 years with a 6 year grace period must be seen as an important element to foster the sustainability of the country's external position.

3. Structural reforms

In both Serbia and Montenegro, the liberalisation of prices continued through 2001 with the abolition of price controls for almost all good categories and the gradual adjustment of prices to more market-oriented levels, in particular for energy in Serbia and for public utilities and essential goods (e.g. milk and bread) in Montenegro.

Significant progress was made in Serbia with the adoption of a new privatisation framework in June 2001 that sets the basis for the privatisation of 150 state and socially owned enterprises through tenders and some 5,000 other companies through auctions on the basis of transparent procedures. According to the new law, foreign investors can obtain up to 70% of shares through public tenders. At end-2001, 35 companies had been put under tendering procedures. The authorities had received bids for the privatisation of three large cement companies, which were expected to be sold in January 2002, somewhat later than initially envisaged. Enterprise restructuring plans for two large loss makers (the car holding Zastava and a big copper producer BOR) were elaborated and a plan concerning the Zastava Company was eventually agreed among the government, the management and unions. A new Serbian law on the Agency for SME development was adopted in November 2001. In Montenegro, the mass privatisation programme that encompasses 450.000 citizens and 221 companies was completed in early December 2001. Moreover, for some 20 companies tendering procedures were initiated (out of 110 enterprises that are going to be privatised through batch sales, tenders or auctions, or to be liquidated). 51% of Montenegro's telecom company was offered for sale in mid-2001 and three investors expressed interest. In 2002, the Montenegrin authorities intend to tender Yugopetrol.

The first fundamental steps to liberalise foreign trade were taken in May 2001, with the adoption at federal level of the Foreign Trade Act, the Customs Tariff and the Tariff Act, which simplified procedures, abolished most licences and quotas, reduced the number of duties and lowered the average tariff rate. In Montenegro, progress was made with regard to trade liberalisation as the number of items subject to restrictions was reduced. Since 2000, Custom tariffs have been reduced substantially from 25% to below 3% on average and are currently lower than in Serbia.

Bank restructuring in Serbia progressed rapidly in line with the Bank Restructuring Strategy that was adopted by the National Bank of Yugoslavia (NBY) in May 2001. After all 82 banks in Serbia had been reviewed, 19 banks were closed and another 15 banks were merged. Licences for five new banks were issued from May to December 2001. A decision to close the four largest banks was announced in early 2002. Although the whole banking system in Serbia has remained extremely fragile, there have been signs of renewed public confidence as evidenced by a substantial revival of savings. In Montenegro, further steps were taken to restructure the banking system. Diagnostic reports for 10 banks were prepared with the support of international advisors. Four banks were re-licensed on the basis of these reports. Moreover, the authorities elaborated and endorsed in principle a plan to restructure the largest bank, Montenegro Banka.

4. Implementation of macrofinancial assistance

On 11 June 2001 an IMF stand-by arrangement covering the period until end-March 2002 was approved and successfully reviewed in October 2001 and January 2002. On 16 July 2001, the Council approved a Community macro-financial assistance of up to EUR 300 million in favour of the FRY, comprising a loan facility of up to EUR 225 million and a grant facility of up to EUR 75 million. Following the clearance of all arrears of the FRY towards the European Investment Bank and the Community, the first tranche of the assistance amounting to EUR 260 million (comprising EUR 225 million loan and EUR 35 million grant) was released in October 2001. A review mission in December 2001 found that the conditions attached to the disbursement of the second tranche (EUR 40 million) had been broadly fulfilled in the following areas: Public expenditure management and control, tax administration and tax policy reform, private sector development, bank restructuring and management of external debt. Following this satisfactory review the second tranche was disbursed in January 2002. On 10 December 2001, the Council approved a revision of its July decision increasing the grant element of the assistance to up to EUR 120 million, thereby augmenting the overall amount of this assistance to up to EUR 345 million.

VIII. THE FORMER YUGOSLAV REPUBLIC OF MACEDONIA

1. Executive summary

The year 2001 was marked by the eruption of ethnic fighting which dramatically affected the population and economy. After several years of positive growth, GDP decreased markedly in 2001 by almost 5%. As a result of the security crisis, the situation of public finances was affected by some slippage in public expenditure, notably military expenditure, and an important reduction of VAT collected. The public finances deficit for the year 2001 was about 6.7% of GDP. Inflation (5.3 %) remained subdued.

Significant progress was recorded in 2001 in implementing structural reforms in a number of areas, notably tax reform, strengthening budget controls, trade policy and public administration. Owing to the spring crisis the fYRoM Government was not able to achieve the objectives of the three-year PRGF/EFF-supported program, approved by IMF in autumn 2000, which was discontinued. As a bridge to a new arrangement, the fYRoM authorities agreed in December with the IMF on a Staff Monitored Programme (SMP) for a period of six months (starting on 1 January 2002).

Following the broad progress recorded in 2001 in the areas of structural reform, against the background of the political and economic crisis in Spring, the disbursement of the second tranche (EUR 10 million grant and EUR 12 million loan) of macro-financial assistance (totalling EUR 80 million) was launched in December 2001 (payment made in early January 2002 on the basis of the SMP). On 10 December 2001, the Council approved an additional macro-financial assistance in the form of a EUR 18 million grant in favour of the fYRoM.

// Summary Status of Economic Reform

// 1. Price liberalisation

Price liberalisation has been essentially completed, except for most utilities and various items such as oil and oil by-products, postal services.

// 2. Trade liberalisation

A small number of tariff and non-tariff barriers remain in place. The recently completed SAA and the Interim agreement will imply more liberal market access for EU products and gradual reduction of tariffs on most important products.

// 3. Exchange regime

From early 1994, de facto peg of the denar to the DM, and now to the Euro; since the devaluation of July 1997 it stands at some 60.5 denar to one Euro.

// 4. Foreign direct investment (FDI)

The environment for FDI has improved. However, approval from the government is still requested to carry out some types of foreign direct investments, while the absence of a properly functioning market for land is also hampering the FDI inflows. FDI inflows have been erratic in recent years and largely dependent on a few large transactions.

// 5. Monetary policy

Monetary policy is conservative and essentially based on the exchange-rate anchor.

// 6. Public finances

In April 2000, the Government introduced VAT and lowered taxation on labour from January 2001 onwards. The Public Revenue Office increased controls in the second half of the year 2001. The Government has launched in 2001 public investment programme focuses on public infrastructure (water supply, road maintenance), the rehabilitation of schools and health centres.

// 7. Privatisation and enterprise restructuring

The privatisation programme begun in 1993; by the end of December 2001, some 1646 enterprises had already been privatised. Privatisation in the agricultural sector is nearly complete. In the second semester 2001, three large industrial enterprises were privatised. The liquidation of a number of loss making companies has been delayed and is expected to take place in 2002.

// 8. Financial sector reform

New banking law of 2000 establishing the legal framework for modernised and strengthened banking sector. The banking sector is already predominantly privately owned. The sector is highly concentrated: the two largest banks, Stopanska Banka (sold in April 2000 to a Greek bank) and Komercijalna Banka, hold about two thirds of total deposits in the banking system.

//

2. Macroeconomic performance

2001 was an exceptional year for the fYRoM owing to the eruption of ethnic fighting in Spring, which lasted until the political settlement of the crisis in August. The crisis dramatically affected the population and the economy. GDP, which had previously been expected to grow at a rate of about 6%, decreased instead by 4.6%, thus causing a negative swing of about 10 GDP percentage points. In addition, the cost of repairs of damaged housing and infrastructure, according to a recent study [2], is estimated at around 1.8% of GDP. The contraction of output affected most sectors of the economy. The level of unemployment, with 29.5% of the labour force by the end of the year 2001 (compared to 32.2% in 2000), reflects the low level of production.

[2] IMG report on damage assessment in the fYRoM, November 2001.

In spite of the crisis, conservative monetary policies based on the external exchange anchor vis-à-vis the DM/EUR have prevented the country from falling into the spiral of high inflation. To stem losses of reserves in the context of the security crisis, the Central Bank in May-June increased reserve requirements and more than doubled its short term interest rates. Consumer prices overall increased by 5.3% in 2001, against 5.8% in the year 2000.

In Spring increased military expenditure in the context of internal fighting put a particular strain on the Government's budget, especially the hiring of new military and police personnel and increases of salaries for special units in the police and the army. Expenditure peaked at 41% of GDP, i.e. 7 percentage points of GDP higher than in 2000. Against this increase in expenditure, revenue decreased markedly. Overall, in 2001 the fiscal revenue decreased by 7% in nominal terms and the overall fiscal deficit reached 6.7% over the year as a whole, against a surplus of 2.5% of GDP in the previous year.

On the external side, a sharp drop of imports, down to about USD 1527 million from a level of USD 1875 million in 2000, allowed for a reduction of the trade deficit to USD 370 million. The current account deficit increased sharply to a level of about 11% of GDP. This high deficit was however to some extent compensated by long term capital inflows from privatisation proceeds in the amount of USD 310 million (about 9% of GDP), following the sale of the national telecom operator in January 2001. Therefore, hard currency reserves, in spite of significant losses over the year, remained significant, in the amount of about USD 779 million at the end of the year, equivalent to 4.9 months of imports. At the end of 2001 the fYRoM was on track with its debt servicing obligations.

The Poverty Reduction and Growth Facility (PRGF) and Extended Fund Facility (EFF) programme agreed with the IMF in late 2000 was discontinued in Spring. In late 2001 the authorities reached an agreement with the IMF on a 6-month Staff Monitored Programme (which started on 1 January 2002), committing to tighter fiscal discipline, with reduced government expenditure at 36.8% of GDP in 2002, down from 41% of GDP in 2001, and which is to be replaced in the course of 2002 by a new upper credit tranche arrangement.

Overall, the situation remains fragile and further consolidation of the civilian peace process is essential in order to re-establish the ground for sustained stabilisation and reform policies as well as economic growth.

3. Structural reforms

Following the liberalisation of bread and flour prices in October 2000, price liberalisation is now essentially completed, except for most utilities, public transport and various items such as oil and postal services.

In spite of the successful sale in January 2001 of 51% of the national telecom company to Matav, the Hungarian operator, privatisation overall slowed down over the year 2001. In the second semester three large industrial enterprises were privatised: Sletovo Battery, Gazella (shoe manufacturer) and Godel (leather work). The privatisation of the state electricity company, ESM, is being prepared with the aim to sell the company by the end of 2002.

Some 40 large loss making enterprises were expected to be either sold or liquidated in 2001: while the crisis delayed the process in the first semester, the authorities have taken action in the last quarter by liquidating one company and commissioning expertise from international consultants on 17 enterprises, the bulk of which are expected to be closed in the course of 2002.

The EU is the main trade partner of the fYRoM and accounts for 48.5% of exports and 41.8% of imports. Following the signature of a Stabilisation and Association Agreement (SAA) between fYRoM and the EC in the year 2000, the first of the kind, the Interim Agreement came into effect in June 2001. Quotas on agricultural and fishery products were abolished. In agriculture, reciprocal trade concessions were agreed (with the exception of wine). The fYRoM concluded Free Trade Agreements (FTAs) with a number of neighbouring countries (including Croatia which is the second country after the fYRoM to have signed an SAA with the EC), EFTA countries and Ukraine. The fYRoM is an observer in the WTO and negotiations which were delayed by the crisis of last year resumed at the end of the year, with a view to achieving full membership in the year 2002.

As of July 2001 the payments functions from the old Payments Office (ZPP) inherited from the socialist era were progressively phased out and transferred to the banking system. In 2001, the authorities reinforced the surveillance of the financial sector, in particular of eight identified problem banks. The rating of three of those banks was upgraded to the necessary minimum. Actions on the five remaining banks were initiated such as the appointment of an administrator, or the merging of two of the problem banks with other banks to improve their financial strength. The sector however continues to suffer from a high level of non performing loans (about 35% were classified doubtful or non performing) and low efficiency, and its development is impeded by the low degree of financial intermediation.

4. Implementation of macro-financial assistance

On 8 November 1999, the Council decided to provide the former Yugoslav Republic of Macedonia with a second macro-financial assistance of up to EUR 80 million (loan up to EUR 50 million and grant up to EUR 30 million).

Following the approval of a PRGF/EFF-supported program by the IMF Executive Board which was delayed until 29 November 2000, a first tranche of the Community assistance amounting to EUR 20 million grant and EUR 10 million loan was disbursed in December 2000/January 2001.

The set of conditions to be fulfilled for the release of the second tranche, included tax reform, strengthening budget controls, trade policy and public administration. Following a review showing broad progress, also taking into account the difficult political and economic situation in the country, the Commission launched the disbursement of the second tranche (EUR 10 million grants and EUR 12 million loans) in December 2001 (disbursed in January 2002 on the basis of a Staff Monitored Programme providing a macro-economic framework).

Moreover, the original Council decision was revised on 10 December 2001, allowing for the extension of the assistance until the end of 2003 and increasing the grant element by EUR 18 million (to a grant total of EUR 48 million out of a total EUR 98 million). This additional macro-financial assistance as well as the outstanding assistance under the original decision will be implemented in the framework of an new IMF arrangement and is subject to specific economic policy conditions still to be negotiated.

IX. GEORGIA

1. Executive summary

Economic growth accelerated in 2001 and is estimated at 4.5% (1.9% in 2000). Inflation remained moderate at 3.4% (4.6% in 2000). The current account position deteriorated somewhat from previous year.

In March 2001 Georgia reached an agreement with the Paris Club following which debt repayments are rescheduled over 20 years with a three-year grace period. Bilateral discussions have not been concluded with all creditors, most importantly with the largest non-Paris Club creditor, Turkmenistan. There are still some concerns around remaining debt service obligations in 2003 and 2004.

The structural reform process slowed down in 2001. There was less interest from foreign investors and announced privatisations in telecommunications and in the energy sector were not finalised. The dismissal of the government in November 2001 created further delays in reform efforts towards the end of the year.

Georgia's three-year arrangement under the PRGF was approved by the IMF Board in January 2001 and Georgia was able to draw a total SDR 27 million by the end of the year from the IMF.

Georgia benefited in December 2001 from a grant tranche of EUR 6 million under the Community's exceptional financial assistance.

// Summary Status of Economic Reform

// 1. Price liberalisation

Most prices have been liberalised.

// 2. Trade liberalisation

Liberal international trade policy. Georgia became a member of the WTO in June 2000. Most import and export restrictions have been eliminated, but the parliament has introduced an export ban on non-ferrous scrap metal (Georgia's biggest export item) from Feb. 2002 as a measure against illegal activities. There have been restrictions on timber exports also.

// 3. Exchange regime

The lari is not subject to exchange restrictions. Floating exchange rate.

// 4. Foreign direct investment

Adequate overall legislation. Unlimited repatriation of capital and profits and no limitations on holding foreign currency bank accounts. Foreign investors are not allowed to own agricultural land, only to lease it. Progressive privatisation establishing title and registering of urban and industrial land.

// 5. Monetary policy

The prudent monetary policy has contributed to the stabilisation of the inflation rate at a low level. Dollarisation of the economy remains high (about 80 percent of deposits are in foreign currencies).

// 6. Public finances

Budgetary revenue (including grants) estimated at 16.5 % of GDP; total expenditure and net lending estimated at 18 % of GDP. An anti-corruption strategy is being implemented. A new budget system law is under preparation.

// 7. Privatisation and enterprise restructuring

Small and medium size privatisation has been largely completed. Currently the focus is on main utilities (telecommunications and the power sector) where the government aims at finding strategic investors or bringing companies under private management, if suitable investors not found. There has been a marked decline in foreign investor interest (due to poor business climate) and progress has been made slowly.

// 8. Financial sector reform

Several measures have been taken to strengthen bank regulation and supervision. Legislation has been amended to establish the authority of the National Bank of Georgia to revoke bank licences. In 2001 the National Bank revoked licences from six failing bank. The minimum capital requirement has been increased. IAS reporting standards and new asset classification and provisioning regulations have been adopted for commercial banks. Public confidence in the banking sector still remains low, however.

//

2. Macroeconomic performance

The macroeconomic situation of Georgia improved in 2001, with an estimated real GDP growth of 4.5 %. This resulted mainly from agricultural production which recovered from the previous year's severe drought. On the other hand, industrial production fell by 1 %.

The general government deficit has been reduced clearly (-7 % of GDP in 1999; -4 % in 2000; -2 % in the first half of 2001) reflecting primarily expenditure cuts but only to a very modest extent improvements in revenues. Georgia has still one of the lowest tax-to-GDP ratios in the region (about 14.5 % in 2001). Revenue collection by the general government was disappointing also in 2001, although total revenues increased slightly in relation to the GDP from the previous year. Weak administration, corruption and smuggling have not been tackled in a way that would bring significant improvements in collection rates. Consequently, the government was not able to reduce the stock of accumulated social expenditure arrears as planned.

The monetary authorities reaffirmed their commitment to maintain low inflation. In 2001 consumer price inflation slowed down to 3.4 % (year-end) from 4.6 % in 2000 (year-end). The lari depreciated about 7 % against the US dollar during 2001, first in the beginning of the year and then at the time of the government crisis in November 2001 (the exchange rate was at about 2,15 lari/USD at the end of the year). Public confidence in the lari remains low, and it has not acquired a savings function yet (foreign currency deposits are at about 80 % of all deposits).

Georgia's current account deficit is estimated to have further deteriorated in 2001 from the previous year when it was at 5.4 % of the GDP, transfers included. Foreign exchange reserves increased at the end of the year but were still low in terms of imports coverage at below 1 ½ months of imports. External debt at end-2001 amounted to around USD 1.7 billion or about 52 % of GDP (53 % of GDP in 2000).

Georgia reached an agreement with the Paris Club in March 2001, following which debt repayments are rescheduled over 20 years with a three-year grace period. Bilateral discussions were not concluded with all creditors by the end of 2001. Most importantly, Georgia continues discussions with its largest non-Paris Club creditor, Turkmenistan. Despite the Paris Club agreement, there are still some concerns around remaining debt service obligations in 2003 and 2004.

Georgia's three-year arrangement under the PRGF was approved by the IMF Board in January 2001 and Georgia was able to draw a total SDR 27 million by the end of the year from the IMF.

3. Structural reforms

Georgia has a relatively liberal international trade regime, but recently there have been increasing political pressures to impose export bans in order to attack illegal activities in the country. The parliament imposed an export ban on timber until the end of 2001, and a ban on non-ferrous metal waste and scrap exports (Georgia's largest export good) which is to become effective in 2002.

Several privatisation initiatives failed to bring results in 2001. The focus has shifted from the remaining large state-owned industrial enterprises (where restructuring is on-going albeit slowly) to main utilities, especially in the telecommunication and the power sectors. There has been a decline in foreign investor interest, due to an unfavourable investment climate, and since it has become more difficult to find suitable strategic investors, the government now attempts to bring the companies under private management as a first step. For instance, in the case of remaining state-owned electricity distribution companies, it is necessary to bring private management which would enforce non-payment cases in order to raise total collection rates.

The National Bank of Georgia (NBG) continued to take steps in strengthening bank regulation and supervision. Licences were revoked from six banks in 2001 but in two cases banks were still able to retain their licences through a Supreme court ruling. The parliament passed amendments to the banking and central bank legislation in October 2001 to establish fully the authority of the NBG in resolution of the problem of insolvent banks. Since February 2001, commercial banks are required to submit monthly reports in line with IAS. The NBG has also issued new asset classification and provisioning regulations in 2001.

Following an anti-corruption strategy which was published in 2000, two Presidential Decrees were issued in 2001 focusing on short-term measures to increase transparency through a broadening of financial disclosure, clarifying the role of government regulatory agencies, carrying out internal audits of government agencies and publication of their expenditures. The implementation of these Decrees started slowly, but after the reshuffling of the government at the end of the year, there has been a renewed intention to focus measures on tax and customs administration.

4. Implementation of exceptional financial assistance

The structural conditionality for the 2001 grant included i.a. conditions on improvement in tax collection rates, reduction of arrears on salaries, pensions and social expenditure, privatisation of the remaining electricity distribution and generation companies and of the telecommunications, and review of bankruptcy legislation. Although substantial progress was made in most of these areas during 2001, in a number of areas progress is lagging, in particular in customs revenue collection, energy sector reform, and privatisation. The Commission decided therefore in December 2001 to disburse a reduced amount of EUR 6 million grant under the Community's exceptional financial assistance to Georgia, after an early principal repayment of EUR 8 million was made by this country on its outstanding debts towards the Community.

X. MOLDOVA

1. Executive summary

Real GDP grew by 6.1% year on year in 2001, according to preliminary data. Despite slow reforms and a relatively weak external environment, the economy is still expected to grow at an annual rate of around 4-5% in 2002-03. This reflects an extremely low base period, following years of steep economic decline, as well as the accumulated effects of gradual reform progress. Moldova's economy will also benefit from relative macroeconomic stability and generally solid import demand in Russia.

Inflation continued to fall dramatically, to 6.4% by the end of 2001, down from 18.4% in 2000 and 43.8% in 1999. The average monthly rise in prices equalled a record low 0.5%, despite a moderate increase in monthly inflation towards the latter part of the year.

Political developments prompted again a standstill in reforms in 2001, in particular in the field of privatisation and enterprise reform.

The government signed a three-year memorandum of understanding in the context of a PRGF with the IMF on 1 December 2000. However, since a new government took office in February 2001, the IMF-programme was continuously off track and no external financing was received.

Given that the release of the first tranche of a EUR 15 million macro-financial assistance loan to Moldova (approved by the Council of the European Union in July 2000), was conditional upon a satisfactory implementation of Moldova's arrangement with the IMF, no disbursements have been made so far under the Community's assistance package.

// Summary Status of Economic Reform

1. // 1. Price liberalisation

The vast majority of prices were liberalised in an early stage of transition. Only very few administered prices are left.

1. // 2. Trade liberalisation

Moldova maintains a very liberal trade regime. The tariff structure features three bands (5,10 and 15%) and the simple average tariff is only 7%. Moldova joined the WTO in 2001.

1. // 3. Exchange regime

Freely floating exchange rate, full current account convertibility.

1. // 4. Foreign Direct Investment

The FDI regime is open and non-discriminatory.

1. // 5. Monetary policy

Conservative policies, aiming at price stability by the use of monetary aggregates as nominal anchors.

1. // 6. Public finance

An impressive, and necessary reduction in the budget deficit was made in 1999 and 2000, mainly by reductions in health care, education and public sector expenditure. No further progress was made in 2001; foreign debt sustainability is critical.

1. // 7. Privatisation and enterprise restructuring

Structural reforms accelerated markedly in 2000. Substantial progress was recorded in the energy sector, land reform was on schedule, whereas the main bottleneck, the privatisation of the economically very important winery and tobacco sectors was finally approved in October 2000. In 2001, no further progress was achieved, and proposals were even made to turn back reforms.

1. // 8. Financial sector reform

The central bank has been successful in implementing banking sector consolidation, and the banking system is sound.

Markets remain undercapitalised.

1. //

2. Macroeconomic performance

The relatively strong performance seen in 2001 is mainly the result of the industrial sector's strong recovery, in combination with the halt in the agricultural sector's decline. Disaggregated GDP data are available only for the first half of 2001. This confirms the dominant role played by the manufacturing sector, which accounted for almost 20% of GDP over the period and was growing at a double-digit rate by the second quarter. Industrial production data for the third quarter show continued, albeit more moderate, double-digit industrial growth. By contrast, the much larger services sector, which is now responsible for more than half of total GDP, grew only marginally over the first half and contributed negligibly to growth over this period. From the expenditure side, domestic demand, particularly by households, accounted for most of the GDP growth seen during the first half of 2001, particularly during the first quarter.

Consumer price inflation fell to 6.4% by the end of 2001, down from 18.4% in 2000 and 43.8% in 1999. The average monthly rise in prices equalled a record low 0.5%, despite a moderate increase in monthly inflation towards the latter part of the year. This increase was primarily attributable to seasonal factors, which drove up the price of food (food prices grew by 3% in December). Monthly inflation in December, at 1.9%, was the highest recorded in almost two years. High inflation and sluggish nominal wage growth prompted a steady decline in real wages throughout 1999 and the first half of 2000. An economic turnaround and sharp disinflation since then have prompted a renewed rise in real wages throughout 2001, particularly as the government has moved aggressively to raise minimum wage levels, according to Economic Trends, by September 2001.

The government has eased fears that it would preside over a considerable fiscal loosening. In late November 2001, it won parliamentary approval for an IMF-supported budget for 2002, and it is unlikely to reverse the fiscal improvements achieved under the previous two cabinets. The IMF requires that the country's budget has to be balanced and if the new administrative-territorial reform, for instance, needs some additional expenses it is necessary to determine their source, whether they will be effected by increase of budget returns or by reduction of other expenditure.

The 2002 budget passed by parliament in late November includes a consolidated deficit of Lei 320 million (USD 24m), or around 1.4% of target GDP. During the final budget debate, parliamentary deputies rejected calls for a further boost to projections for both revenue and expenditure.

The government financed its budget deficit in 2001 through new central bank loans, which totalled approximately Lei145m between January and September, and sales of government securities, which reached Lei119m over the same period. When first formulating its budget for 2001, the government had planned to finance its deficit from privatisation receipts and multilateral inflows, neither of which proved forthcoming.

The current-account deficit for the third quarter of 2001 increased to USD 49 million, compared with USD 35 million in the third quarter of 2000. This resulted from the rise in the merchandise trade deficit sparked by a slowdown in export sector growth over the course of 2001, and continued high levels of import expenditure. The rising current-account deficit also represents a drop in the transfers surplus, owing to low levels of grants, and an increase in the services deficit, which was brought on by a decline in exports of travel and transportation services. These considerations more than outweighed the sharp increase in the income surplus brought on by increased remittances from Moldovans working outside the CIS (the NBM counts remittances as income). Owing to the sharp fall in the second-quarter deficit, the cumulative deficit in January-September is still somewhat narrower than that recorded during the year-earlier period.

Official foreign exchange reserves were roughly constant during the last two years, at just over USD 200 million, or between 2.5 and 3 months of imports.

3. Structural reforms

Privatisation of the wineries, tobacco plants and utilities were earlier con