REPORT FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT

on the implementation of macrofinancial assistance to third countries in 1994

(95/C 357/01)

Contents

Page

I. OVERVIEW . 3

1. Introduction . 3

2. Macrofinancial assistance in 1994 . 4

II. ALBANIA . 25

1. Introduction . 25

2. Macroeconomic performance . 25

3. Structural reforms . 26

4. Implementation of macrofinancial assistance . 27

III. ALGERIA . 28

1. Introduction . 28

2. Macroeconomic performance . 29

3. Structural reforms . 29

4. Implementation of macrofinancial assistance . 30

IV. BALTIC COUNTRIES . 31

1. Introduction . 31

2. Recent economic developments . 31

Estonia . 31

Latvia . 32

Lithuania . 33

3. Implementation of macrofinancial assistance . 34

V. BULGARIA . 34

1. Introduction . 34

2. Macroeconomic performance . 35

3. Structural reforms . 36

4. Implementation of macrofinancial assistance . 37

VI. MOLDOVA . 37

1. Introduction . 37

2. Macroeconomic performance . 38

3. Structural reforms . 39

4. Implementation of macrofinancial assistance . 39

VII. ROMANIA . 40

1. Introduction . 40

2. Macroeconomic developments . 41

3. Structural reforms . 42

4. Implementation of macrofinancial assistance . 43

VIII. SLOVAKIA . 43

1. Introduction . 43

2. Macroeconomic developments . 44

3. Structural reforms . 45

4. Implementation of macrofinancial assistance . 47

IX. UKRAINE . 47

1. Introduction . 47

2. Macroeconomic performance . 48

3. Structural reforms . 49

4. Implementation of macrofinancial assistance . 49

I. OVERVIEW

1. Introduction

Initially conceived for intra-Community balance-of-payments support, macrofinancial assistance from the Community has been extended since 1990 to third countries, mainly those of Central and Eastern Europe, with a view to supporting their political and economic reform efforts. As they embarked on their process of transition to a market economy, the countries of this region were faced with similar problems:

- The costs attached to the first steps of reform, liberalization and stabilization, were substantial; in particular: commitment to unify the exchange markets and make the national currency convertible for current account transactions at an early stage of the reform process required raising the level of international reserves of those countries; and some countries were also over-burdened by a sizeable public debt inherited from the previous regime.

- In addition to the needs relating to the transition efforts, the Central and East European countries (CEECs) faced additional external shocks: the consequences of the Gulf War, including the embargo which had particularly severe effects in economies such as Bulgaria; the dramatic collapse of the Comecon trading system, which had been based on State-directed flows of goods at artificial prices; and later, the effect to the trade embargo on Serbia-Montenegro.

- The sums available from the international financial institutions (IFIs) - mostly the IMF and the World Bank - were insufficient.

- Flows from the private sector were virtually non-existent because of the relative unfamiliarity with the economies concerned and the great uncertainties surrounding the first stages of the reform and transition process.

Against this background, the European Community decided to extend macrofinancial assistance to the countries in the region in complement to the financing provided by the IFIs. It was also decided that, in the context of the assistance coordination process agreed among the 24 industrial countries (G24) to help the CEECs, the Commission should get other donors to contribute in a similar way to support the economic programmes that these countries were implementing in agreement with the IMF and World Bank.

In early 1991, at the initiative of the European Commission, a set of principles was agreed among the G24 that have since served as guidelines for EU/G24 macrofinancial assistance; accordingly, the operations have conformed with the following principles (1):

(i) exceptional character: all operations are undertaken on a strictly case-by-case basis. The operations are to be discontinued when the recipient country can fully rely on financing from the IFIs and private sources of capital;

(ii) complementarity: the basic prerequisite for the mobilization of the assistance is the existence of a significant residual external financing gap over and above the resources provided by the IMF and other multilateral institutions and despite the implementation of strong economic stabilization and reform programmes;

(iii) conditionality: the assistance is generally released in successive tranches, the disbursement of each of them being conditional upon the fulfilment of macroeconomic performance and structural adjustment criteria, consistent with the economic programmes agreed between the beneficiary countries and the IMF.

A number of such support operations by the EU and the G24 took place from 1990 to 1993 covering most Central and East European countries eligible for G24 assistance (Table 1).

- The first Community macrofinancial operation for a third country dates back to February 1990, when the Council decided to provide Hungary with a five-year ECU 870 million loan facility in support of the country's efforts to overcome structural adjustment difficulties in the context of an IMF standby arrangement.

- In 1991, the Council adopted four new decisions granting financial assistance to CEECs totalling ECU 1 220 million: ECU 375 million for Czechoslovakia; ECU 290 million for Bulgaria; ECU 375 million for Romania and a further ECU 180 million for Hungary (2).

- In late 1992, another series of Community operations was decided by the Council for CEECs, amounting to ECU 480 million, comprising: a further ECU 110 million loan for Bulgaria; a further ECU 80 million loan for Romania; an ECU 220 million loan to the Baltic States (40 million for Estonia, 80 million for Latvia and 100 million for Lithuania), and a grant of ECU 70 million to Albania (3).

Outside the region of Central and Eastern Europe, two other Community loan operations were decided by the Council in 1991. In the context of Community support for Mediterranean countries adversely affected by the Gulf conflict, the Council made available to Israel an ECU 160 million soft loan in July 1991. In September 1991, a medium-term loan of ECU 400 million was also decided in favour of Algeria to help the country carry through the political and economic reforms under way (4).

2. Macrofinancial assistance in 1994

In 1994, Community macrofinancial assistance was provided to a series of countries in Central and Eastern Europe, the European newly independent States (NIS) issued from the former Soviet Union, and the Mediterranean area, in a total amount of ECU 620 million (Table 1).

New operations in favour of CEECs comprised a further loan of up to ECU 125 million for Romania; a further grant of up to ECU 35 million for Albania; and a loan of up to ECU 130 million for the Slovak Republic. Furthermore, the loan to Bulgaria, which had been decided in 1992, but could not be disbursed owing to bad macroeconomic performance in 1993, was reactivated in 1994 in the context of a new economic programme. As in previous years, all these initiatives were taken in the context of G24 financing packages complementing resources provided by the IFIs. Overall, the requests for exceptional financial assistance from the G24 totalled US$ 977 million, of which the Community contributed approximately half (bringing cumulative requests for G24 assistance to US$ 4,3 billion since 1991, Table 2).

Operations in favour of European NIS comprised a loan of up to ECU 45 million for Moldova; and of up to ECU 85 million for Ukraine; These initiatives were taken in the context of exceptional international assistance coordinated by the World Bank, that mobilized respectively US$ 130 million, and US$ 185 million of new financing to complement resources by the IFIs. In the case of Ukraine, Russia and Turkmenistan also provided substantial bilateral contributions through restructuring of their claims.

With respect to the Mediterranean region, the loan to Algeria (ECU 400 million), decided in 1991, was reactivated in 1994 in the context of a new economic programme supported by the IMF; and the second tranche (ECU 150 million) was disbursed. In the same context, a further loan to Algeria for an amount of up to ECU 200 million was decided in late 1994. Again, these initiatives were part of an international concerted effort to provide exceptional complementary assistance, that involved bilateral contributions of new financing as well as debt-restructuring operations from Paris Club and London Club creditors.

Each Community operation has continued to respond to the set of principles established in 1991. In particular, EU macrofinancial assistance has supported efforts by recipient countries to bring about economic reforms and structural changes. In close coordination with the IMF and the World Bank, is has promoted policies tailored to the specific national needs, designed to stabilize the financial situation and set up market-oriented economies, (macroeconomic performance and progress in reforms in beneficiary countries are summarized in Tables 4 and 5 and discussed country by country in the following chapters).

Towards a more policy-oriented approach

With the large geographical scope of macrofinancial assistance operations initiated in 1994, the economic conditions among beneficiaries have shown a great diversity. However, beyond these differences, the EU macrofinancial instrument has evolved significantly. In particular, in the case of the CEECs:

- Macrofinancial support has been part of a much broader effort by the EU to comfort the transition process in Central and Eastern Europe and to establish closer links with its neighbouring countries. The framework for that effort has been further clarified; in particular, Association Agreements were signed between 1991 and 1995 with most of these countries. Moreover, a decisive step was taken at Copenhagen, in June 1993, when the European Council accepted the goal of Union membership for those associated countries and put forward political and economic measures to create more favourable conditions to this end. Macrofinancial assistance, which possible use was explicitly mentioned in the chapter on financial cooperation of the Association Agreements, was therefore to be seen in the context of a long-run partnership with the associated countries. The European Council of Essen in December 1994 has confirmed the conclusions of the European Councils in Copenhagen and Corfu that the associated States of Central and Eastern Europe can become members of the European Union if they so desire and as soon as they are able to fulfill the necessary conditions. It has decided to boost and improve the process of further preparing the associated States of Central and Eastern Europe.

- The achievement of a successful transition towards a market economy increasingly appeared as a complex, protracted process. More specifically, the necessary links between macroeconomic stabilization and structural adjustment (and the need to put more emphasis on structural reforms) became more obvious. For the IMF, it translated into a better integration of those aspects into the programmes that were negotiated with the authorities of those countries. In parallel, the World Bank helped the authorities to design specific programmes centred around key reforms in the enterprise and financial sectors, to be supported by policy-based lending operations with conditionality relating to progress with structural reform.

From the European Union's point of view, all this has affected the timing and the content of the programmes. EU lending has evolved towards a more policy-oriented role and a greater synergy has been achieved with grant-based EU instruments (mostly the EU-PHARE programme). This can be illustrated by the operations initiated in 1994 with Bulgaria, Romania and the Slovak Republic.

Macroeconomic imbalances persisted and reform remained elusive in Bulgaria and Romania throughout 1993. Arrangements concluded in 1992 with the IMF and the World Bank ran off track, and discussions on new comprehensive programmes dragged on during most of 1993. At the same time, the newly independent Slovak Republic was experiencing difficulties coping with the huge loss of transfers that it had received under the Federation. For those countries, it was therefore important that financial assistance be available when a renewed willingness to progress with stabilization and reform emerged. This happened in late 1993 early 1994 when authorities in all three countries decided to engage in new comprehensive programmes that could be supported by the international community. The European Union decided at this juncture to respond favourably to the request for further macrofinancial assistance in the context of G24 to complement IMF and World Bank arrangements.

Although the total amounts of resources committed by the G24 have not been, in relative terms, as large as in the previous operations, the coordination between the Commission and the Bretton Woods institutions has been more intense. Also the policy dialogue with the authorities in the countries concerned has broadened considerably.

The dialogue established with the authorities in the framework of macrofinancial assistance involved a two-stage process.

- In the first stage, the main objective was to concur in the rapid implementation of key policy measures at the outset of the programme.

- In the second stage, the main objective was to assess the government's strategy for structural reform. Two major fields of investigation were the privatization process and the restructuring of the public enterprise sector. In parallel, discussions were held with EU-PHARE services with a view to finding appropriate ways to strengthen the capacity of the relevant national institutions to handle these tasks.

In both areas of stabilization and structural reform, policies have been monitored in close cooperation with the IMF and the World Bank.

Macrofinancial assistance to countries other than associated CEECs has also evolved, although to a lesser degree. Operations could not be embedded in a context of long-term partnership similar to that with associated countries; however, more emphasis has also been put on structural reforms. In the case of Moldova and Ukraine, where macrofinancial assistance initiated in 1994 has been supporting efforts at an early stage of the transition to market economies, these have included the introduction of the necessary legislative framework as well as the implementation of important structural reform, in particular in the key areas of liberalization of foreign trade, introduction of convertibility and price liberalization (that were started to be put in place at the beginning of the decade in most associated CEECs).

In Albania, where the first stage of economic stabilization and reform had been successfully achieved, assistance has been supporting the shift by the Albanian authorities from a mainly short-term horizon, that had been dictated by the state of crisis, towards a consistent medium-term approach in the framework of a comprehensive medium-term economic programme. In Algeria, resumption of assistance by the EU has been supporting renewed efforts towards the establishment of a convertible market-based exchange rate, the liberalization of trade and prices and the tightening of financial discipline for the State-owned enterprises.

Burden-sharing

While EU macrofinancial assistance has been evolving towards a deepened policy-oriented approach, resources mobilized by the Union in this context have been decreasing substantially (Tables 3 and 3.1). Initially, an important feature of EU assistance was that very large sums of money were to be found to support Bretton Woods institutions' programmes. The EU played a key role both as the largest single provider of these funds, (mobilizing 54 % of total balance of payments support to Hungary in 1990) and through its role as the coordinator of bilateral assistance (the G24 process for CEECs since 1991), which ensured a wide participation in this effort.

Eventually, more resources were mobilized by the IFIs (whose contribution increased from 21 % of balance of payments support - excluding debt relief - in 1991 to some 70 % in 1994): a new lending instrument, the systemic transformation facility (STF) was created which, together with the increase in the access limits, enabled the IMF to increase its assistance to CEECs and countries of the former Soviet Union. The World Bank, for its part, developed successive generations of policy-based balance of payments operations (structural adjustment loans (SAL), followed by financial and enterprise and financial sectors adjustment loans (EFSAL) (5).

In parallel, contributions by external creditors, both public and private, were mobilized in the framework of debt-relief and debt-reduction operations (Algeria, Bulgaria, Ukraine), accounting for a substantial share of balance of payments support in 1991 and 1994.

In this context, relative contributions (6) from the EU and from other bilaterals (beyond debt-relief operations) declined sharply from 54 % and 25 %, respectively in 1990 to 17 % and 12 %, respectively, in 1994 (or 6 % and 5 %, respectively, of total commitments including debt-relief operations).

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Table 2 EU/G24 macrofinancial assistance to Central and Eastern Europe since 1991 (cumulative amounts) (Status as of December 1994)

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Source: European Commission.

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Table 3 Balance of payments support to recipients of EU macrofinancial assistance by contributor, 1990 to 1994 (1) (in % of total commitments)

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Table 3.1 Balance of payments support to recipients of EU macrofinancial assistance by contributor, 1990-1994 (in US$ million and in % of total commitments and disbursements)

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II. ALBANIA

1. Introduction

Albania's macroeconomic and structural adjustment efforts were initiated in 1992 against a background of severe economic, social and administrative dislocation. The government's decisive efforts to address the crisis when it assumed office in April 1992 have been largely successful. The economic programme for the period mid-1992/mid-1993, which was supported by an IMF standby arrangement and complementary financial assistance from the EC (7) (ECU 70 million in the form of a grant) and bilateral G24 members, reversed the slide into hyperinflation and the downward spiral of output, and initiated profound changes towards a market economy. Against this background, the Albanian authorities could shift from a mostly short-term horizon towards a consistent medium-term approach when they embarked on a three-year comprehensive arrangement with the IMF under an enhanced structural adjustment facility (ESAF) in mid-1993 (US$ 60 million). In support of this IMF programme, the Council of Ministers decided on 28 November 1994 (8) to grant Albania further macrofinancial assistance of up to ECU 35 million in the form of straight grants in the context of an initiative of the G24 aiming at mobilizing a total of US$ 72 million.

Albania has been successfully implementing the economic adjustment efforts contemplated in the first and second annual arrangements under the ESAF. A number of structural reforms fell behind schedule during 1994. The Albanian Government, however, has recently taken new initiatives to accelerate structural adjustment.

2. Macroeconomic performance

Macroeconomic performance during 1994 was very satisfactory. Inflation in the 12 months to December was reduced to some 15 %, compared with a programme target of 24 %. Output is estimated to have continued to grow at a sustained pace (some 7,5 %, following 11 % in 1993), led by private activity in agriculture, construction and service sectors. The external current account performed better than programmed, owing in particular to export buoyancy and sustained private transfers. This successful macroeconomic out-turn reflected the maintenance of tight fiscal and monetary policies; in particular, the targeted domestic financing of the budget deficit was contained at 8 % of GDP. External reserves remained above programmed levels.

Based on this performance, the Albanian Government and the IMF have recently agreed on a macroeconomic framework and the main features of the budget for 1995: the objectives include real GDP growth of 6 %, a reduction in inflation to 10 % (December/December) and a further increase in external reserves. To this end, a key policy instrument is the reduction in the government domestic financing requirement to no more than 7 % of GDP.

To achieve this budget objective, the government has decided at end-January to implement a new fiscal package that includes the elimination of customs tariff exemptions. Furthermore, the authorities agreed to introduce VAT in mid-1995 to replace the existing turnover tax; to introduce a simplified customs tariff rate system, and to further reduce civil service employment.

These policies are expected to further improve external accounts, allowing for some additional build up of reserves (before debt rescheduling). Furthermore, with regard to the status of negotiations with external creditors, the authorities have recently reached an agreement on external arrears (of some US$ 500 million, excluding interest) with the banks' advisory committee.

Exports still cover only a fraction of import needs. However, reflecting the exodus of young unskilled labour to neighbouring countries (mostly Greece), expatriate remittances account for a significant fraction of national income and largely outweigh exports as a source of foreign exchange (US$ 230 to 260 million a year against US$ 110 to 140 million in 1993 to 1994). In the circumstances, they have helped maintain a stable exchange rate and finance the incipient private sector (mostly trade and construction) including through the development of an informal financial sector. Current account deficit declined sharply (from 66 % of GDP in 1992 to 13,5 % in 1994), but Albania still relies heavily on public external financing in particular to meet its investment needs in its infrastructure projects.

3. Structural reforms

The early liberalization of prices, foreign trade and the exchange rate regime have been major achievements of Albania's Government in recent years. Most price controls and subsidies were eliminated in 1992 to 1993. For bread and energy, the government decided to cushion the social impact of those measures by the introduction of a targeted compensation scheme, to be phased out within a limited period. With regard to energy, the price adjustment resulted in a drop of bill collection together with a sizeable increase in 'non-technical losses' (thefts), dramatic power cuts at the end of 1994, and the need to resort to power imports.

Foreign trade has been largely liberalized: there are no quantitative restrictions on imports; on the export side, licensing is only required for a very limited number of goods. The exchange rate has been floating since July 1992 within a unified exchange market, the efficiency and depth of which has been greatly improved by the early licensing of foreign exchange dealers and exchange bureaux (with PHARE technical assistance to the central bank).

Dramatic changes have taken place in the agriculture sector, following the privatization of former cooperatives' land and the liquidation of former State farms. Some 96 % of total arable land is now reported to be in private hands and agricultural output has bounced back (increasing by 14 and 7 % in 1993 and 1994, respectively). However, land registration is far from complete and the distribution of temporary titles of property has come to a halt since mid-1994; furthermore, the recipients of former State farm land have only a status of 'users' of that land; and the small size of private plots (1,5 ha on average) is an obstacle to further productivity gains, while the consolidation of those strips into larger units is prevented by the lack of an effective land market.

Privatization of small shops and of the public housing sector was implemented quickly in 1992, through direct sales to employees and tenants at token prices. Following the passage of legislation on restitution and compensation in early 1993, the authorities proceeded with the privatization of small and medium-sized enterprises, through a decentralized procedure, under the responsibility of local authorities. At present, the process is largely complete and has allowed these small-scale enterprises to remain in operation and to stimulate private activities. Concerning the biggest State-owned enterprises (SOEs), progress so far has been mixed; with an obsolete capital stock, clearly, large sections of industry are no longer viable and cannot operate on commercial terms now that budgetary support has been severely reduced; furthermore, the administration does not have the capacity to carry out a large-scale restructuring, and there is no tradition and experience of export-oriented production and marketing.

Banking sector reform made little progress in 1994. The three, specialized, State-owned banks (the Savings Bank for household deposits, the National Commercial Bank (NCB) for the enterprise sector, and the Rural Commercial Bank (RCB) for the agriculture sector) are still burdened with bad loans despite previous attempts at cleaning up those debts. In fact, both the NCB and the RCB are virtually bankrupt, while the Savings Bank is not fully autonomous from the central bank. In the circumstances, a strategy has not yet been designed for each of those banks. Meanwhile, informal banking activity has developed. This informal sector seems to have been effective and helpful, even though its interest rates are reported to be very high.

In early 1995, the government of Albania took a series of measures and made new commitments to remedy the situation in different areas.

Concerning the agriculture sector, the government took the measures needed to establish an effective land market, including completing the land registration and the distribution of 'tapis' (temporary titles), as well as the conversion of 'user' status into that of lessee.

In the area of privatization and enterprise sector reform, specific measures are contemplated in the three categories of large enterprises (the most problematic sensitive enterprises, public utilities and resource-based enterprises, and other enterprises):

- the first group is made up of 32 SOEs under the responsibility of the Enterprise Restructuring Agency (ERA); the government has set clear objectives in terms of privatization or liquidation (the latter requires new legislation); it has also singled out a group of five enterprises which account for about half of the total number of employees in ERA enterprises, for which an explicit strategy is to be adopted soon;

- regarding public utilities and resource-based enterprises, where very little was done in 1994, the government has recently prepared draft legislation in order to allow an eventual privatization of those enterprises;

- for the 'other enterprises', the government's objective is to have them privatized rapidly including through a mass privatization scheme. However, special attention will be devoted to the necessity not to hamper strategic foreign investment in the process.

No strategy has yet emerged for the future of the three State-owned banks. Business plans are being prepared, but their scope is essentially limited to the rationalization of the management of the banks. More substance is expected from the results of the external audits that are due to start soon. Then it would be possible to adopt a strategy for those banks. Also, licensing procedures are to be streamlined in order to facilitate the entry of new banks, and possibly the registration of part of the current informal, underground, banking sector.

Meanwhile, the Central Bank is striving to improve its capacity and effectiveness, in particular through the establishment of instruments of monetary policy that would allow it to go beyond the reliance on bank-by-bank credit ceilings.

4. Implementation of macrofinancial assistance

On 28 November 1994, as mentioned above, the Council of Ministers adopted a further macrofinancial assistance to Albania up to a maximum amount of ECU 35 million. This grant is complementary to assistance provided by the IMF under a three-year enhanced structural adjustment facility (ESAF) initiated in mid-1993, with a view to ensuring a sustainable balance of payments situation and strengthening the reserve position of the country.

The first tranche (ECU 15 million) of this assistance was disbursed in May, following signature of the Memorandum of Understanding (Mou) laying down the macroeconomic and structural conditionality attached to the assistance.

The disbursement of the second tranche is expected to take place later this year, subject to satisfactory progress being recorded in Albania's application of the ESAF and to a positive evaluation of progress made with respect to structural reforms. In this evaluation, particular attention will be paid to progress in the fields of liberalization, external debt, budgetary reform, public investment, enterprise and banking sectors, and agriculture.

III. ALGERIA

1. Introduction

In September 1991, the Council decided to grant an ECU 400 million loan to Algeria, to be disbursed in two tranches (9). The loan agreement and the corresponding Memorandum of Understanding specifying the conditions for disbursement, were signed in December 1991. The first tranche of ECU 250 million was immediately released as the two conditions attached to it - conclusion of a standby agreement with the IMF and a commercial debt refinancing and reprofiling agreement between Algeria and its commercial bank creditors - were met.

In accordance with the Memorandum of Understanding, the release of the second tranche of ECU 150 million was subject to two sets of conditions: (a) respect of the quantitative macroeconomic performance criteria agreed in the context of the IMF programme and (b) a positive assessment by the Commission of the progress accomplished in specific areas of structural reform. However, by mid-1992, the programme with the IMF had gone off-track and the macroeconomic performance criteria were not complied with.

A new government came to power that halted most of the economic reform programmes and reversed some of the liberalisation measures taken. Throughout 1993, strict price controls, administrative import management and a stringent foreign currency allocations regime choked economic activity. The appreciation of the real exchange rate and lax fiscal policy increased the fiscal deficit. Towards the end of the year, the decline in hydrocarbon export revenue led to unsustainable pressure on Algeria's debt service capacity.

In this context, negotiations started with the IMF at the end of 1993, which resulted in the approval of a 12-month Standby arrangement (10) for an amount of approximately US$ 1 billion in May. In June, Algeria, for the first time, obtained an agreement from the Paris Club on a rescheduling of bilateral debt service due during the programme period with the IMF. Furthermore, the programme received financial support from the World Bank, the Arab Monetary Fund, the African Development Bank and Japan. The authorities also addressed a request to the Commission for the rapid release of the remaining second tranche of the 1991 assistance package as well as for further macrofinancial assistance under the new programme.

2. Macroeconomic performance

Since the adoption of the new economic programme, progress has been made in the stabilization of the economy and the implementation of economic reforms. The Algerian dinar was devalued by some 45 % and the fixed exchange-rate regime was replaced by a managed float, aiming at a stabilization of the real effective exchange rate. Prices, imports and access to foreign currency were substantially liberalized. Consumer subsidies have been gradually reduced and a more effective social safety net is being put in place.

Financial discipline for State-owned enterprises has been tightened and the first steps towards privatization have been taken.

The fiscal deficit dropped from 9,2 % of GDP in 1993 to 5 % in 1994 and the 1995 Budget law is targeted at a 2 % deficit. Monetary policy was tightened and interest rates were increased, although not yet at positive levels in real terms. Despite the strong devaluation and a series of price adjustments, inflation increased moderately from 21 % in 1993 to 29 % in 1994 and monthly inflation is expected not to exceed a 10 % annual rate by the end of 1995. Economic growth, however, has not picked up as foreseen under the programme with the IMF. GDP growth for 1994 was revised downwards from 3 % to around zero, partly attributable to a drought affecting agricultural production but also to political and security problems which may, if the trend is not reversed, hamper the proper implementation of the economic reform programme.

Export revenue, mostly from hydrocarbon products, further declined in 1994, in spite of an increase in world oil prices. Imports increased by 15 % following the liberalization of the import and foreign exchange regimes. Shortages of consumer and investment goods have been eliminated. As a result of these liberalizations, the current account deteriorated, as foreseen under the programme, from a US$ 0,8 billion surplus in 1993 to a US$ 1,7 billion deficit in 1994 and the overall balance of payments registered a US$ 4,4 billion deficit in the same year. This has been financed mainly through bilateral debt rescheduling agreed with the Paris Club (the equivalent of some US$ 3,6 billion). Negotiations with the London Club of commercial bank creditors were also started but have not come to a final conclusion yet. Commercial debt service reduction contributed some US$ 0,8 billion to balance of payments financing in 1994.

Exceptional financing has permitted the Bank of Algeria to clear some US$ 0,5 billion of arrears and strengthen its international reserve position, which reached nearly US$ 2,2 billion (2,4 months of imports) at end-1994, up from US$ 1,4 billion early-1994.

3. Structural reforms

Stringent administrative import controls and foreign currency allocations were abolished in April 1994 and replaced by a more liberal regime comprising a system of professional criteria for importers and a limited list of prohibited imports. The latter list has been gradually reduced and was abolished end-1994, except for goods prohibited for religious and security reasons. The list of goods subject to professional criteria is also being reduced and is expected to be abolished towards the end of 1995. State monopolies on certain imports have also been eliminated. Access to foreign currency has been completely liberalized for all visible current account transactions by private and public enterprises. Only imports financed through foreign credits are still subject to authorization.

The five State-owned banks have been audited regularly since 1992 and institutional development plans have been put in place. The Bank of Algeria has strengthened its supervisory capacity and established more effective prudential regulations and controls. Although banks are free to set their own creditor and debtor interest rates, a ceiling of 5 percentage points has been imposed on the spread between average creditor and debtor rates for each bank. In 1995, management contracts are expected to be signed between the Ministry of Finance and bank managers. Banks will receive a banking licence provided that prudential ratios, set by the Bank of Algeria, are respected.

The legal environment for private enterprises improved considerably. A commercial code was promulgated in 1993, putting private and public enterprises on a equal legal footing. The investment code authorizes foreign investments in all sectors of the economy and provides for the full repatriation of profits. A competition law was adopted in January 1995 which liberalizes the price regime and puts stringent limits on cartels and monopolies.

Nearly 400 public enterprises were given autonomous status in 1992 and their management was transferred to several participation funds. Restructuring plans have been prepared for the remaining 23 non-autonomous public enterprises and, following the signature of management contracts and a one-off injection of rehabilitation funds by the treasury, they are scheduled to become autonomous by the end of 1995.

The possibility of privatizing public enterprises was first introduced in the 1994 budget law that authorized the sale of public assets. A pilot privatization programme comprising five hotels was launched in November 1994. A privatization law and a more comprehensive privatization programme are currently in preparation. The present political and security situation is, of course, not conducive to private sector investments, both domestic and foreign, in Algeria.

4. Implementation of macrofinancial assistance.

Following the agreement in principle between the Algerian authorities and the IMF in April 1994 and a request for further macrofinancial assistance from the Algerian authorities, the Council endorsed the Commission's intention to release the remaining second tranche of the 1991 programme and agreed in principle on additional macrofinancial assistance for an amount of ECU 200 million.

The second tranche of ECU 150 million was effectively disbursed in August and the Commission proposal for an additional ECU 200 million macrofinancial assistance, to be disbursed in two tranches, was adopted by the Council on 22 December 1994 (11). A Memorandum of Understanding specifying the conditions related to the disbursement of the first tranche of ECU 100 million was agreed with the Algerian authorities in early 1995. The structural reform conditions relate to further liberalization of the imports and exchange rate regimes, reforms in the financial sector and progress towards restructuring and privatization of public enterprises. Furthermore, the Memorandum emphasizes Community concerns in the social sector and synergy between macrofinancial assistance and other Community aid instruments, which could facilitate the implementation of economic reforms in Algeria. Disbursement of this first tranche will take place as soon as the economic reforms agreed upon in the Memorandum have been implemented, normally by mid-1995, and provided that the IMF programme remains on track.

The conditions related to the release of the second tranche will be negotiated at a later stage, after the disbursement of the first tranche and the approval by the IMF board of a new programme with Algeria.

IV. BALTIC COUNTRIES

1. Introduction

The three Baltic States, who recovered their sovereignty in August 1991, had already initiated reforms under the past regime after the adoption by the Supreme Soviet of the bill on their economic independence in November 1989. In 1992, as they were already actively engaged on the way of reforms to a market economy, economic prospects worsened. The dismantling of trade relations among former Soviet republics and the increase of prices of energy imports from Russia to world levels resulted in a trade shock and an expected deficit of their external accounts which were expected to be unsustainable without international support. The three countries defined stabilization and reform programmes covering the period mid-1992 to mid-1993 and concluded standby arrangements with the IMF. G24 donors were called to contribute to fill the remaining expected balance of payments gap for the programme period, estimated at a level of US$ 105 million for Estonia, US$ 210 million for Latvia and US$ 285 million in the case of Lithuania. On the basis of favourable prospects of support within the G24, the IMF board approved the standby arrangements in September and October 1992.

In November 1992 the EC Council approved macrofinancial assistance of up to ECU 220 million (12) for the three countries (ECU 40 million for Estonia, ECU 80 million for Latvia and ECU 100 million for Lithuania) in support of the countries' programmes. The bulk of the remaining bilateral support within the G24 came from Japan and EFTA countries. Loan agreements and Memoranda of Understanding between the Community and each beneficiary were signed in early 1993. The Commission disbursed the first tranches (50 % of the loan amounts) in March 1993 for Estonia and Latvia, and in July 1993 for Lithuania. The release of the second tranches was made subject to positive evaluation of performance criteria, regarding both macroeconomic stabilization aspects and progress of structural reforms, as set in the Memoranda of Understanding.

2. Recent economic developments

Estonia

Estonia had started to implement liberalization measures, mainly on prices, already under the previous Soviet regime in 1990 and 1991. The Bank of Estonia was re-established in 1990. In March 1992 most import duties were abolished, except for a few goods like cars, tobacco and alcohol. Prices liberalization had been almost completed by mid-1992. In June 1992 the Estonian kroon was introduced and pegged to the German mark at a rate of EEK 8 to DM 1 German Mark under a currency board arrangement. The new restrictive monetary policy, which under the currency board is constrained by the level of foreign exchange reserves held in the central bank, proved successful in stabilising the economy and bringing back inflation down to two-digit levels in 1993. The kroon parity vis-à-vis the German mark has not been modified since 1992.

Latest developments are favourable. The economy emerged from recession by the end of 1993 and GDP is estimated to have grown by 6 % in 1994, despite a severe drought which hampered agricultural production. Monetary growth under the currency board discipline remained moderate and fell to a level of 30 %. The general government budget was overall in balance, reflecting improvements of revenue performance. Inflation remained however high with the consumer price index (December on December) increasing by 47 %. After the establishment of the Estonian Privatization Office in 1993 to better coordinate policies towards the enterprise sector, privatization accelerated in early 1994. While the process of small-scale privatization is almost complete with 1 500 small enterprises sold, 258 large-scale enterprises had also been sold by the end of the year.

The shift of the country's trade to the West was sharp: in 1994 EU and EFTA countries accounted for 65 % of exports and over 70 % of imports. The recovery of growth and of investment-related imports lead to substantial imports. Despite a sharp growth of exports, the trade balance last year was negative for the first time since 1991 and the current account deficit reached 6,5 % of GDP. However, owing to substantial inflows of private foreign direct investments, the capital account recorded a substantial surplus, which allowed foreign exchange reserves to continue increasing. On 1 January 1995 the Free Trade Agreement with the European Union entered into force. A Europe Agreement was signed in June 1995. Estonia becomes an associated country to the European Union.

The programme under the IMF standby arrangement for the period October 1993 to March 1995 remained on-track and in March 1995 the Fund approved a new standby arrangement of an amount of SDR 14 million (about US$ 21 million) for a new 15-month period. However, it is expected that the Estonian authorities will not draw on this facility unless needed.

Latvia

Reforms in Latvia had already started under the previous Soviet regime, as in the other Baltic States. Prices and the external trade liberalization were fully completed by mid-1992. A two-tier banking system was established in 1992. In mid-1992 the country left the rouble zone, introduced a temporary currency (the Latvian rouble) and initiated stabilization measures, in particular a strict monetary policy, and further structural reforms. Latvia pursued a strict budgetary discipline, which lead to a surplus of the general government budget in 1993 (0,6 % of GDP) after a low deficit in 1992 (0,8 %). The privatization of small firms was initiated in 1992. A national currency, the Lat, was introduced in summer 1993. The fight stabilization measures produced significant results. By the end of 1993 inflation had been brought down to 35 % (December to December).

Developments in 1994 were broadly positive. After a sharp contraction of output during the previous years (GDP fell by 35 % in 1992 and 15 % in 1993), GDP stabilized and started to grow again, by 2 %. Inflation continued to decline to a 26 % level (December to December). The financial deficit of the budget was kept within the 2 % target, despite significant wages and pension increases. However, owing to the authorities' decision to lend to the Latvian electricity utility to clear external gas arrears vis-à-vis Russia, the fiscal deficit which stood at 4 % of GDP was higher than anticipated.

While exports remained stable relative to 1993, imports grew significantly in 1994, which lead to a significant current account deficit of about 3,4 % of GDP, against a surplus in 1993. However, as in 1993, the capital account was in surplus mainly owing to large private capital inflows, which allowed for a further consolidation of the country's level of foreign exchange reserves, worth five months of imports. On 1 January 1995 the Free Trade Agreement with the European Union entered into force. A Europe Agreement was signed in June 1995.

The authorities maintained the momentum of structural reforms. In order to consolidate the financial sector, the balance sheets of the two major banks, the Universal Bank of Latvia and the Latvian Savings Bank, were strengthened. In the context of a tighter banking supervision nine banks had their licences withdrawn in 1994. In November the authorities launched auctions for the privatization of 68 large enterprises, which had been delayed pending the settlement of property rights issues.

The IMF standby programme for the period December 1993 to March 1995 remained on track. The Latvian authorities and the IMF reached an agreement on a new standby arrangement for a 13-month period which the IMF board approved in April 1995, for an amount of SDR 27,45 million (about US$ 41 million). As in the case of Estonia however, it is not expected that the authorities will make use of this facility, unless their level of reserves becomes tighter.

Lithuania

Structural reforms in Lithuania had already started in February 1991, when firms were allowed to raise their prices within certain limits. By early 1992 most prices had been freed. Privatization was also initiated in 1991. Vouchers were distributed in April, and small firms auctions started in September of this year. In spring 1992 Lithuania left the rouble zone and issued a temporary currency, the talonas. In July 1993 a new currency, the lita, was introduced. However reforms were slower in other areas, in particular macroeconomic stabilization, external trade liberalization and the financial sector. Deregulation and the shift within the price structure led to a high inflation peaking in 1992 at a 720 % (average) level. Monetary policies however were tightened in spring 1993 and a sound management of the State budget, which was kept in surplus, allowed inflation to decrease in 1993 (190 %, year average).

After several years of recession GDP stabilized and rose slightly in 1994 (+ 2 % estimate). In April 1994 the government introduced a currency board arrangement, according to which the money is circulation is constrained by the amount of hard currencies held in the Bank of Lithuania. The lita is pegged at a fixed rate of LTL 4 to US$ 1. This was a major step in the stabilization of the economy. Monetary growth under the new arrangement was kept moderate and inflation further decreased down to 45 %. The 1994 State budget was in deficit of about 3 % of GDP owing to lower than expected government revenues, particularly over the first semester. The slow registration of newly established private sector firms, as well as delays encountered in the transition from a general excise tax to a value-added tax explain this poor revenue performance. The external trade was further liberalized in May, when the authorities suppressed import tariffs on several goods: by that time, two thirds of imports were zero rated, while most of the other imports carried a 10 % rate. In July however import tariffs on a broad list of agricultural goods were raised to an average 40 % level. The share of the West in the country's external trade is continuing to increase. About 50 % of Lithuania's exports are now directed to Western markets. Lithuania's trade and current account have been in deficit since 1993. In 1994 the current account recorded a US$ 375 million deficit (i.e. 0,4 % of GDP). Owing to substantial public and private capital inflows this deficit was largely covered by the capital account's surplus. Foreign exchange reserves which are all the more crucial under the currency board arrangement continued to increase and covered about three months of imports by the end of the year. On 1 January 1995 the Free Trade Agreement with the European Union entered into force. A Europe Agreement was signed in June 1995. Lithuania becomes an associated country to the European Union.

The year 1994 was also a year of change in core structural areas. Privatization continued to progress; by September 76 % of all eligible companies, representing 30 % of the initial State assets, had been privatized. In December the central bank law was enacted, and was followed by the adoption of the commercial banking law in early 1995. Performance under the standby arrangement agreed with the IMF for the period October 1993 to March 1995 was satisfactory. Following the approval of the government three-year programme last Autumn, aiming at a sustained 5 % growth of GDP, the IMF approved, 24 October, an SDR 134,55 million (about US$ 202 million) extended facility replacing the current standby programme. This should allow Lithuania to build up the necessary reserves and to finance key energy and investment related imports.

3. Implementation of macrofinancial assistance

In view of the above, the Commission considers that performance criteria attached to the Community loan facilities have been broadly met by all three countries. The Baltic States have successfully implemented stabilization policies agreed with the IMF, which renewed its support by the means of a three-year extended facility (EFF) for Lithuania in October 1994, and new standby arrangements with Estonia and Latvia respectively in March and April 1995.

As signs of an economic recovery in the three Baltic States are accumulating, it is expected that their current account positions will deteriorate in 1995 to 1996, driven by a high demand of investment-related imports. These countries may therefore experience substantial current account deficits over the next few years and would have to rely heavily on capital inflows. Owing to the expected increasing demand for investment-related hard currency finance in these countries, the Commission after consulting the Monetary Committee exceptionally agreed, in supplemental Memoranda of Understanding negotiated with the authorities, to channel the bulk of the second tranches of the loans, through the domestic banking sectors, to finance sound projects.

The disbursement of the second tranche of the loans has however been delayed. In the case of Latvia and Lithuania, this was due to the Commission's request in early 1994 of further evidence of progress on structural reforms, in particular in the areas of privatization and financial sector reform. In the case of Estonia, which has advanced more quickly on both stabilization and structural reforms, the release of the second tranche was delayed pending clarification from the authorities on their readiness to channel the bulk of the proceeds of the loans through the banking sector.

V. BULGARIA

1. Introduction

During most of 1993, the Bulgarian economy went through a crucial transition phase. Real GDP further declined, the budget deficit deteriorated, domestic bank credit expanded fast, financial discipline of State enterprises weakened and the pace of the ambitious reform and structural adjustment process slowed down significantly. Moreover, the central bank (BNB) managed the exchange rate through sizeable interventions in order to contain the lev depreciation, kept price and trade liberalization and made progress in the field of fiscal reform. As a result of serious policy slippages, weak macroeconomic management and a growing uncertainty on the reform pace, in 1993 the country was virtually cut off from the international financial support, and was unable to reach an agreement with the IMF on a new standby arrangement.

During the last quarter of 1993 the overall economic climate improved significantly owing to two major events:

- a preliminary agreement was reached with Bulgaria's commercial creditors for a comprehensive debt and debt service reduction programme (DDSR);

- a new, credible policy programme for 1994 was formulated.

In April 1994 the IMF approved a global assistance package of US$ 421 million (of which US$ 97 million as a 12-month standby and US$ 324 million as systemic transformation facility). In July Bulgarian authorities finalized the debt reduction arrangement with their commercial bank creditors. In order to enable Bulgaria to meet debt-reduction-related up-front disbursements, the Fund and the World Bank decided in September to augment their financial contribution by US$ 225 million.

In the framework of the G24 coordination process, the Community decided in April to reconfirm its commitment of a loan of ECU 110 million which, if appropriate, could be increased to 150 million (13). The rest of G24 financial commitments in favour of Bulgaria amounted to US$ 93,7 million.

2. Macroeconomic performance

The policy programme for 1994 focused on the urgent need to implement a tight fiscal and monetary policy aimed at restoring the domestic and external equilibrium. These policies rather than interventions by the Central Bank should lead to the stabilization of the exchange rate. The stabilization policy was associated with an ambitious structural reform programme based upon further rationalization and privatization of state assets, a strengthening of financial monitoring of loss-making enterprises, completion of the restitution programme and a more stringent control on access to credit.

Achievements have been mixed. In 1994 the Bulgarian economy stopped shrinking. Real GDP increased by 1,4 % (-2,4 % in 1993). Industrial production grew by 4 % (-8,5 % in 1993), reflecting a more favourable business climate, the expansion of the private sector and new export opportunities. Agriculture grew by 11 % in 1994; in services there was an overall decline. Unemployment declined from 16 % in 1993 to around 13 % in 1994, reflecting partly the economic turnaround and the deletion from labour office registration lists of a significant number of unemployed who became ineligible for social benefits

Despite a tight monetary and credit policy, significant price fluctuations occurred in 1994 as a result of price liberalization and setbacks to economic policy, particularly exchange rate turbulences. The year-on-year CPI inflation reached 121,9 % (63,8 % in 1993).

In 1994 the government implemented a restrictive fiscal policy, aimed at reining in fiscal deficit and hardening the budgetary constraint facing State-owned enterprises. Nominal non-interest expenditure rose less than inflation, subsidies have been cut to around 2 to 3 % of GDP and the budget deficit/GDP ratio contracted to 6,7 % (15,7 % in 1993).

The government's planned incomes policy in 1994 was moderately restrictive, with nominal wage upper ceilings consistent with projected inflation targets. Due to higher-than-expected inflationary pressures, incomes, (in particular those in the public sector) declined sharply in real terms.

As regards Bulgaria's external developments, the structural shift in foreign trade towards OECD was further consolidated, reflecting the positive impact of association and trade agreements with EU and EFTA, the lev devaluation, and low labour costs. In 1994, trade balance showed a surplus of US$ 200 million (against a deficit of 900 million in 1993) and the current account was balanced (against a deficit of US$ 1,4 billion in 1993).

Foreign direct investment remained extremely low (US$ 105 million), despite liberal legislation passed in January 1992. However, external official financing greatly contributed to the replenishment, by year end, of Bulgaria' foreign exchange reserves to around US$ 1 billion, equivalent to three months of imports.

As regards foreign debt management, the DDSR Agreement with the London Club was brought to closure on 28 July, 1994. Overall, it is estimated that the Agreement reduced Bulgaria's 8,2 billion US$ debt to Western commercial banks by 46 to 48 %. The up-front costs of the operation (US$ 715 million) were partly covered by Bulgaria's hard currency international reserves (US$ 474 million) and partly by exceptional official external financing (US$ 241 million). Furthermore, in April 1994 a third Paris Club debt rescheduling arrangement was reached between Bulgaria and its official creditors, covering all obligations falling due from the previous rescheduling until 30 April 1995. Following these arrangements, Bulgaria's relations with the international financial community were restored.

3. Structural reforms

Despite a number of constraints, policy slippages, political uncertainty and weak management, Bulgaria was successful in maintaining during 1994 previous policy achievements such as price and trade liberalization, current account convertibility and a liberalized exchange rate regime.

A number of unresolved problems remain however as regards enterprise restructuring, privatization and the reform of the financial system.

With respect to price liberalization it is estimated that at present around 90 % of all retail turnover takes place under a free price regime. However, price controls are still maintained on several products and services including energy, telecommunications, water supply and transports. Despite several upward adjustments, these administered prices in 1994 have not kept pace with inflation. The government is committed to progressively winding up existing indirect price controls on agricultural products (minimum producer prices, minimum import prices, maximum margins, etc.).

The progress in trade liberalization since 1992 has been encouraging but uneven. Export prohibitions have been removed and export quotas on some 10 products have been replaced with export taxes. The 3 % import surcharge was lowered to 2 % in January 1994 but by mid 1994 the government still kept some temporary trade barriers to protect domestic industry and agriculture, in the form of minimum import prices, import licences, etc. Bulgaria's interim Association Agreement with the EU entered into force on 1 January 1994.

Bulgaria's foreign exchange rate regime has been liberalized, effective on February 1994. Foreign exchange ceilings for current personal payments (tourism etc.) by residents have been raised significantly and current account convertibility is ensured for trade-related payments. Some restrictions on current payments and transfers are however still in force.

Significant progress has been accomplished in the field of property restitution which triggered a fast development of a dynamic, private retail and trade sector (it now accounts for over 50 % of all retail and wholesale trade in the country).

The state enterprise sector is weak and debt-ridden. Budget constraints on enterprises are too soft and credit ceilings by the banking system are circumvented via the accumulation of inter-enterprise arrears (at present they may account for about one quarter of the value of industrial production). In order to tackle these problems the government's strategy focuses on implementing financial rescue plans, enterprise restructuring and privatization.

A law passed in December 1993 authorized the government to issue long-term bonds in both domestic and foreign currency aimed at replacing uncollectable, lev and dollar-denominated loans and interest arrears accumulated in banks' portfolios by end of 1991. Loans to State enterprises will therefore be borne by the government which eventually might convert them into equity or decide on their write-off or rescheduling as soon as companies are restructured or privatized.

In the field of restructuring, major steps undertaken during 1994 include the formulation by main loss-making enterprises of comprehensive loss-reduction and rationalization plans, and the development of a mechanism to monitor bank credit to these enterprises, with a view to strengthening their financial discipline.

As regards privatization, in 1994 the government was determined to accelerate the programme implementation by amending the Privatization Law with the aim to facilitate a standard, market-based privatization via the Privatization Agency, complete the small scale privatization and carry out, in parallel, a mass privatization scheme involving 500 medium and large-scale enterprises. However, owing to the absence of the required political determination by the interim government to carry out the programme, the implementation of mass privatization has been delayed and privatization through standard methods proceeded only slowly.

At present the Bulgarian banking system is still affected by a number of constraints, including undercapitalization, inadequate management, insufficient supervision by the central bank on capital adequacy and prudential regulations, a slow privatization process, lack of financial discipline ('easy credit'), fragmentation and a growing number of non-performing loans to enterprises. In order to cope with this highly disturbing situation, several actions have been undertaken in 1994. The capability of the Banking Supervision Department at the Bulgarian National Bank has been strengthened. Two regular full on-site inspections to problematic banks were carried out by mid 1994 and two more were programmed by year end. A bank consolidation programme was completed under the aegis of the Bank Consolidation Company (BCC) so that 66 public sector banks were merged into 11 major banks. Bad loans clean-out proceeded but the gradual recapitalization of the banks progressed only slowly owing to its budgetary cost. In 1994 a timetable for a gradual privatization of some banks was prepared and is expected to be carried out by the end of 1995.

4. Implementation of macrofinancial assistance

The disbursement of the ECU 110 million Community loan decided in October 1992 in the framework of G24, as a complement to the IMF assistance to Bulgaria, was delayed as the 1992 standby arrangement with the Fund went off track. For the same reason no other G24 assistance was released under this initial package. At the end of 1993 conditions were restored for the resumption of EU/G24 assistance to Bulgaria. Following the adoption of a new IMF standby arrangement, on 16 May 1994, the Council of the EU agreed with the Commission that the 1992 decision on Community macrofinancial assistance to Bulgaria could be reactivated in the context of the new programme. The release of a first tranche (ECU 70 million) took place in December 1994 on the basis of the approval of the new IMF standby and the debt relief arrangement agreed between creditors. The release of the second tranche is conditional upon observance by Bulgaria of standard macroeconomic performance criteria including a satisfactory track record of the IMF standby, a proper implementation of DDSR operation and progress with structural reform.

VI. MOLDOVA

1. Introduction

On 13 June 1994 the Council of the European Union decided to grant the Republic of Moldova a loan of ECU 45 million with a maximum duration of 10 years (14) to assist the country in its efforts to transform its economy to a market economy and to strengthen the reserve position of the central bank. The Community loan was part of an overall package mobilized by the international donor community in favour of Moldova to complement the resources provided by the IMF and the World Bank.

2. Macroeconomic performance

Following the introduction, in November 1993, of its national currency - the Moldovan leu - Moldova has made a decisive turn towards financial stabilization in the context of the economic programme supported by an IMF standby arrangement (approved in December 1993) and complementary assistance from the international community, including the ECU 45 million Community loan.

The programme was implemented in a very difficult environment. Real GDP is estimated to have fallen by about 22 % in 1994, compared with an anticipated decline of 3 %. This is in part attributable to the continuing disruptions to output and trade associated with the collapse of central planning. Industrial production fell by about 30 % in the first semester of 1994, before stabilizing in the second half of the year. Furthermore, a severe drought, followed by flooding and hailstorms, devastated key crops in this mostly agricultural country in the third quarter of 1994.

Despite this unfavourable economic environment, the Moldovan authorities demonstrated considerable resolve and consistency in the pursuit of financial stabilization. Reviews under the IMF standby arrangement were successfully completed in June and December 1994, and all performance criteria for end-December 1994 were met. The key objective of the programme was a rapid and sustained reduction in the rate of inflation based on the introduction of the leu, and a stabilization of the exchange rate. As a result of the firm implementation of the programme, inflation decelerated sharply in 1994. The monthly rate of inflation fell from a average rate of about 20 % in the fourth quarter of 1993 to an average rate of about 3 % in the fourth quarter of 1994. As inflation subsided, the exchange rate stabilized and the credibility of the leu was enhanced (as reflected by the reversal of currency substitution), allowing a decline in nominal and real interest rates.

Fiscal deficit for 1994 was contained to 8 % of GDP, despite the greater-than-envisaged decline in real output and inflation. However, liquidity problems in the enterprise sector impeded tax collection and resulted in the assumption by the government of guaranteed loans to enterprises in default. Furthermore, expenditure arrears rose by some 1,5 % of GDP, including arrears on wages, as a result of the application of a strict cash management system.

The balance of payments remained under severe pressure throughout 1994 primarily as a result of higher prices for imported energy and the effects of natural disasters. Based on preliminary data, the current account deficit was equivalent to 9 % of GDP. Moldova was highly dependent on foreign assistance, the disbursement of which covered some 50 % of total imports. The IMF and the World Bank contributed some 56 % of total foreign assistance, and other bilaterals some 44 %, including the EU (ECU 25 million corresponding to the first tranche of the macrofinancial assistance), Japan (US$ 30 million), the US (US$ 20 million) and Romania (US$ 10 million). Furthermore, arrears to Russia mostly by Moldovan enterprises for energy imports reached the equivalent of US$ 120 million. With the pace of disbursements in foreign assistance increasing late last year, gross reserves of the central bank reached the equivalent of three months of imports at end-1994.

At this critical juncture of the stabilization process, the Moldovan authorities have formulated an ambitious strategy for 1995 with the objective of consolidating the progress in stabilization and intensifying structural reforms. The programme that is supported by a new IMF standby arrangement approved in March 1995 requires further complementary financing from the international community.

The programme aims at economic growth of 1,5 %, led by a recovery in the agricultural sector with the return of normal weather conditions, a reduction in the annual rate of inflation to about 10 % and the containment of the deficit in the current account of the balance of payments. To these ends, fiscal policy is centred on sharply reducing the budgetary deficit to the equivalent of 3,5 % and monetary policy is to remain tight.

In the first quarter of 1995, the Moldovan authorities have strictly implemented the financial policies contemplated in their programme. Based on preliminary data, all performance criteria for end-March have been met, including a better-than-expected foreign exchange position of the central bank. This has resulted in a stable exchange rate and a containment of inflationary pressures (15).

3. Structural reforms

The progress made in terms of structural reform in 1994 was mixed. State enterprises remained largely unresponsive to market forces (which resulted, inter alia, in the increase in arrears to the budget and to external suppliers of energy as indicated above), owing in part to the weakness of the bankruptcy and liquidation process, and delays in privatization. However, towards the end of the year, there was a substantial acceleration of reform efforts, as the authorities recognized that further delays in implementing structural reforms threatened to undermine the stabilization gains. A new streamlined auction procedure was introduced, that facilitated the implementation of an ambitious schedule for the auction of State enterprises. The government also decided to identify and initiate liquidation proceedings against seven of the most problematic State enterprises.

The acceleration of structural reforms in late 1994 is to be sustained in 1995 through an accelerated privatization programme, the establishment of the legal basis for bankruptcy proceedings, the strengthening of the capital base of the banking system and the development of indirect, market-based monetary controls.

The acceleration of the reform efforts that started in the last quarter of 1994 has continued in 1995. In particular, a new ambitious privatization programme covering 1995 and 1996 was approved by the Parliament on 15 March, that covers a substantial portion of the remaining State assets, and introduces along the existing voucher system, privatization for cash (in order to provide new liquidity to enterprises for post-privatization restructuring and to open privatization to the participation of foreign investors). The pilot liquidation of seven enterprises is now well under way, the Liquidation Committee, that performs asset sales and the payments of creditors has been formed, and five of these enterprises have been liquidated. The liquidation of further 15 enterprises through the same procedure is contemplated before end-June. A bankruptcy law has been prepared; a new draft law to approve prudential regulation and ensure the autonomy of the central bank is at present before Parliament; and action plans to ensure capital adequacy for 10 problematic banks were agreed by the central bank in January.

4. Implementation of macrofinancial assistance

The Community loan of ECU 45 million decided on 13 June 1994 was to be disbursed in two tranches, upon fulfilment of the macroeconomic conditions attached to it. The first tranche, of ECU 25 million, was disbursed in December 1994, on the basis of the successful completion of the first programme review under the IMF standby arrangement. The disbursement of the second tranche, of ECU 20 million, was conditional upon a successful track record of the IMF standby arrangement and subject to a positive evaluation by the Commission of performance criteria and of progress made with respect to structural reform in the areas of price, trade and foreign exchange liberalization, privatization, and financial discipline of enterprises and the financial sector.

Progress has been indeed substantial in these different areas. Prices of goods and services were fully liberalized in the course of 1994, with the exception of energy products, rent for housing, telecommunications, public transport, communal services and the State procurement price for grain. Subsidies on agriculture products were eliminated in May 1994, whereas energy subsidies were removed and replaced, for the most vulnerable groups of the population, by a cash compensation system.

Trade liberalization has advanced considerably: all export quotas were removed with the exception of grain and grain products. By end-1994, Moldova lowered its maximum import tariff to 50 %, with the exception of a small number of luxury goods, primarily wine products and consumer electronics. Import tariffs have been reduced to no more than 30 % on 1 April 1995 and a further reduction is expected by end-1995.

In the area for foreign exchange arrangements, authorization was granted to non-residents in July 1994 to repatriate profits and the proceeds of liquidation of their enterprises; also, the foreign exchange surrender requirement for export earnings by enterprises was eliminated in November 1994. Interbank foreign currency exchange has been established, where residents can purchase foreign exchange for most current payments and non-residents can purchase foreign exchange to repatriate earnings.

In the area of privatization, the process was slower than expected but accelerated during the last months of 1994, so that, by end-December, 304 medium and large and 273 small enterprises had been privatized, representing 25 % of total State assets. The 1995 to 1996 privatization programme was approved by the parliament on 15 March 1995, whereby two-thirds of State assets will be privatized by end-1996.

Regarding the reform of the banking sector, the National Bank of Moldova (NBM) is working on the new regulations that meet the standards set up by the Basle Committee. The new regulation binding the commercial banks to classify their portfolio and establish provisions for bad loans was recently approved. A new draft banking law has been prepared and submitted to the Parliament. This law provides for the independence of the NBM in conducting monetary policy, as well as for the additional rights of the NBM in supervising and controlling the activities of commercial banks. The new draft banking law also provides for penalties in case of infractions to prudential regulations.

In view of the measures taken and commitments for further action provided by the Moldovan authorities, the conditions attached to the disbursement of the second tranche of the Community loan are considered to be met.

In order to ensure a sustainable balance of payments situation in 1995, further macrofinancial assistance in favour of Moldova to complement the resources provided by the IMF and the World Bank will be necessary, as was recognized by the international donor community in the framework of the Consultative Group meeting organized by the World Bank in March 1995. Following the disbursement of the second tranche, the Commission intends to present a proposal for further macrofinancial assistance to Moldova of up to ECU 15 million.

VII. ROMANIA

1. Introduction

In the course of 1993, inflation accelerated in Romania in the wake of substantial price liberalizations. Loose monetary policy and a lack of financial discipline in State-ownedenterprises (SOEs) further fuelled inflation to over 300 %. Interest rates were steeply negative and resulted in a flight out of the leu into foreign currency holdings. The National Bank of Romania (NBR) continued to administer the official rate and multiple exchange rates persisted, with the gap between the official and the (private) exchange bureaux' exchange rate reaching more than 50 % by the end of the year. NBR foreign reserves shrank to less than US$ 50 million by end-1993, equivalent to three days of imports, while commercial banks held some US$ 1 billion in foreign assets. Very little was achieved in the areas of SOE restructuring and privatization. Despite some progress in fiscal reforms and a reduction of the fiscal deficit to 2 % of GDP, the IMF was not in a position to continue its financial support for Romania in 1993 and no complementary EU/G24 macrofinancial assistance could be mobilized either.

Only in December 1993 did the authorities reach an understanding with the IMF on a new economic programme for 1994 to 1995. In May 1994, the IMF board approved this programme and the accompanying financing facilities (standby and systemic transformation facility) for an amount of US$ 700 million, following EU/G24 financing assurances for the residual gap.

2. Macroeconomic developments

The main objectives of the 1994 to 1995 programme are to reduce annual inflation to around 70 to 75 % by the end of 1994 and to significantly diminish the current account deficit. To achieve these objectives, the authorities pledged to increase interest rates to positive levels in real terms, to liberalize the exchange rate regime, to limit the fiscal deficit to 2,5 % of GDP in 1994 and to speed up privatization and financial restructuring of State-owned enterprises.

Monetary policy was tightened towards the end of 1993, when the NBR started to auction off part of its refinancing credits at market-determined interest rates. This resulted in a general increase in interest rates throughout the banking system to positive levels in real terms. The average cost of NBR refinancing rose to more than 12 % per month in early 1994, at the time when inflation rates fell to 5 to 8 % per month. Nominal interest rates started to decline again, although slowly, in the second and third quarters of 1994, in line with inflation. The average NBR refinancing rate decreased to around 5 % per month at the end of 1994, when inflation had slowed down to around 2 % per month. Interest rates practised by commercial banks followed a similar pattern.

The increase in interest rates renewed confidence in the leu and narrowed the gap between the official exchange rate, fixed by the NBR, and the rate in the private exchange bureaux. After a nominal depreciation of some 14 % in February and March 1994, the NBR abandoned the administered exchange rate regime and switched to a market-determined exchange rate in early April. An interbank foreign exchange market was established in August. However, in the third quarter of 1994, a significant gap between official and private bureaux exchange rates re-occurred and persisted throughout the first quarter of 1995, although decreasing at a slow pace. This indicated that the foreign exchange market was not functioning in a fully transparent way and that the official exchange rate was not fully market-clearing.

The consolidated fiscal deficit actually showed a small surplus for the first five months of 1994. But this situation was not sustainable as expenditures were artificially held down until May 1994 because the new budget law was not yet approved by parliament. By the end of the year, the fiscal deficit had reached ROL 2 070 billion or 4,4 % of GDP. This was in line with the nominal deficit criteria set out in the programme with the IMF. As a percentage of GDP, it exceeded the initial programme objective because of the stronger than expected slowdown in inflation that led to a downward revision of nominal GDP estimates for the year.

Tax reforms continued in 1994 with the introduction of new profit tax, local tax and land tax laws and increased excise duties. Monetary financing of the fiscal deficit through NBR credits to the government was almost completely phased out between March and November 1994. However, strong increases re-occurred in December of that year when the government reverted from the commercial banks to the NBR to finance part of its deficit.

Strict monetary and fiscal policy resulted in a rapid decrease in inflation, from over 300 % per year in November 1993 to less than 62 % per year at end-1994, considerably below the target of 75 % in the IMF programme. The authorities have now set a new annual target for 1995 at 25 %, rather than the 40 % envisaged initially in the programme.

The current account deficit was considerably reduced, from US$ 1,2 billion in 1993 to US$ 0,3 billion in 1994. This was due to a strong export performance (+23 % in dollar terms), driven mainly by the depreciation of the leu and by substantial payment arrears and delays in the domestic market that encouraged enterprises to sell abroad. Imports increased by about 5 % only. Towards the end of 1994 and in early 1995, current account pressures emerged again, partly as a result of the appreciation of the leu in real terms.

The capital account showed a marked increase in private direct and portfolio investments, reaching US$ 414 million, compared to US$ 14 million only in 1993. But a slowdown has been registered in loan disbursements compared to the timing in the programme. As a result, the capital account surplus in 1994 remains below the programme target.

Official foreign exchange reserves, that were almost depleted at the end of 1993, increased to more than US$ 620 million (1,2 months of imports) by mid-October 1994. However, in the wake of the re-occurrence of the exchange rate gap and the authorities' apparent willingness to keep the official exchange rate below the market-clearing level, the National Bank sold part of its reserves. They fell to less than US$ 407 million at the end of February 1995, when the National Bank resumed the purchase of foreign exchange. Foreign exchange holdings in the overall banking system increased from US$ 0,9 billion in January to US$ 2 billion in December 1994.

3. Structural reforms

Imposing financial discipline on arrears- and loss-making State-owned enterprises is a key objective in Romania's 1994 to 1995 economic stabilization programme. However, interenterprise arrears increased to some ROL 7 billion or 14 % of GDP by end 1994. Almost half of these arrears are accounted for by some 70 companies and 'regies autonomes' which have been targeted for strict financial surveillance. This includes isolation from the banking system, negotiation of conciliation agreements with their creditors, and drawing up and implementation of financial recovery plans. If no conciliation could be reached, commercial insolvency procedures would be activated. Liquidation is, of course, not a realistic solution for most of the public utilities and viable financial recovery programmes would have to be established.

Parliamentary approval of the long-overdue Commercial Insolvency Law came in March 1995. This law is a key element in this financial recovery strategy as it defines the proper legal framework for out-of-court conciliation procedures between creditors and debtors. It will permit the initiation of bankruptcy proceedings while allowing sufficient flexibility for rescue operations.

Privatization of State-owned enterprises has not made much progress. End-1994, three years after the approval of the privatization law, less than 900 out of nearly 6 300 State-owned companies had been fully transferred to private ownership. Most of these were small companies, privatized through management-employee buy-outs. A new mass privatization programme was announced by the government in June 1994 with the aim of privatizing another 3 000 enterprises by June 1995. However, this programme was approved by parliament in only March 1995. It was foreseen that at least two of the five major State-owned banks should be prepared for privatization in 1995 but only one bank has so far been nominated, the Romanian Development Bank.

4. Implementation of macrofinancial assistance

Following Romania's agreement in principle with the IMF on a new programme for 1994 to 1995, the authorities requested the EU and the G24 to grant further macrofinancial assistance to Romania to cover the residual external financing gap of US$ 275 million under the 1994 to 1995 programme. Commitments by the EU/G24 reached some US$ 219 million or nearly 80 % of the residual gap. This includes further EU macrofinancial assistance for an amount up to EC 125 million, in two tranches, decided by the Council on 20 June 1994 (Decision 94/369/EC). In December 1994, the Commission agreed with the Romanian authorities the macroeconomic conditions attached to the disbursement of the loan.

However, by May 1995, the first tranche of ECU 55 million had not been disbursed because of slippages in Romania's exchange rate policy that occurred in the last quarter of 1994 and the first quarter of 1995. The Commission has, on several occasions, expressed concern to the Romanian authorities over these slippages and emphasized the need to re-establish a unified exchange rate at a fully market-clearing level before disbursement procedures can be activated.

The disbursement of the second tranche is linked to the effective implementation of specific structural reform measures, including progress in privatization, financial restructuring of loss-making enterprises and banking sector reforms agreed upon with the Romanian authorities in the Memorandum of Understanding.

VIII. SLOVAKIA

1. Introduction

The dissolution of the Czech and Slovak Federal Republic (CSFR) on 1 January 1993 had several negative implications for the Slovak economy at a time when it was still suffering from the shock associated with the dismantling of the Council of Mutual Economic Assistance and from the difficulties accompanying the transition to a market economy. In particular, the dissolution of the federation implied the loss of substantial fiscal transfers from the Czech lands, which contributed to the emergence of high budget and current account deficits in 1993. Also, the division of the CSFR disrupted trade with the Czech Republic, restricted Slovakia's access to the international capital markets, and was followed by speculation against the Slovak crown which practically depleted Slovakia's official foreign exchange reserves.

In this context, the Slovak Government agreed with the IMF in mid-1993 on a macroeconomic stabilization programme for the rest of that year, which was supported by the approval in July 1993 of a first purchase in the amount of SDR 64,4 million (about US$ 100 million) under the IMF's systemic transformation facility (STF). In addition, the World Bank granted Slovakia a US$ 80 million economic recovery loan in November 1993.

In July 1994, the IMF approved a 20-month standby credit and a second purchase under the STF totalling SDR 180 million (or about US$ 280 million), in support of a more comprehensive economic programme for 1994 to 1995. In parallel, the World Bank began discussions on a possible enterprise and financial sector adjustment loan (EFSAL). The macrofinancial assistance programme agreed with the international financial institutions aimed at strengthening Slovakia's delicate balance of payments position and at supporting the country's transformation into a market economy following the shock associated with the split of the CSFR.

In support of this programme, the EU Council adopted on 22 December 1994 (16) a decision making available macrofinancial assistance to Slovakia in the amount of up to ECU 130 million, as part of a G24 initiative to respond to the request by the Slovak authorities for complementary assistance (in the amount of US$ 300 million). Other members of the G24 (mainly Japan, Austria and Switzerland) made further commitments amounting to US$ 87,3 million.

2. Macroeconomic developments

All macroeconomic variables have been evolving favourably since the second quarter of 1994. Following four consecutive years of recession, the Slovak economy recovered strongly in 1994, with real GDP growing by 4,8 % and industrial production by 7 %. The recovery of GDP was driven by a strong expansion of net exports, which more than offset a new decline in domestic demand. The unemployment rate, for its part, has stabilized, although at a relatively high level of about 14,5 % (it stood at 14,6 % in March 1995). GDP is projected to grow again by about 4 % in 1995 as domestic demand replaces net exports as a source of growth.

Year-on-year consumer-price inflation has declined from 25 % in December 1993 to 11,3 % in March 1995, and the government's programme aims at further reducing it to 8 % by end-1995. Wage growth, by contrast, accelerated in 1994, with real wages in the industrial sector growing by 7 % after declining in 1993. The government, however, has decided to abolish the tax on excessive wage increases introduced last year.

Substantial progress was made in 1994 in reducing the budget deficit. The deficit of the general government closed the year at 2,7 % of GDP, down from 7,6 % in 1993. The budget for 1995 is consistent with a general government deficit of around 3 % of GDP. Also monetary policy was tight in 1994. The net domestic assets of the banking system expanded by only 2 %, compared to the 5,5 % growth that had been programmed and with a 11,1 % growth in 1993. The money supply, however, grew faster than programmed, reflecting the rapid expansion of net foreign assets, in turn a consequence of the turnaround in the balance of payments position. The NBS will continue to conduct a prudent monetary policy in 1995. It has decided to maintain until end-1995 the individual credit ceilings on banks introduced in February 1994, and will aim at a 4,5 % growth of net domestic assets and a 12,3 % growth of M2 in 1995.

The balance of payments has experienced a clear improvement since the second quarter of 1994. The current account swung from a deficit of US$ 0,6 billion (5,4 % of GDP) in 1993 to a surplus of US$ 712 million (6 % of GDP) in 1994. The main factors behind this improvement seem to be the decline of domestic demand, the devaluation of the Slovak crown (including within the bilateral clearing system) and the imposition of the 10 % import surcharge in March 1994.

The improvement in the current account has been particularly market vis-à-vis the Czech Republic, with the bilateral balance reaching a US$ 806 million surplus in 1994. The turnaround in Slovakia's current account vis-à-vis the Czech Republic has been reflected in the balance of the bilateral ECU clearing account. Following a substantial deficit position for Slovakia in late 1993 and early 1994, the account has been showing a Slovak surplus, with the Czech Republic consistently exceeding the ECU 130 million credit limit beyond which payments must be settled in hard currency.

The capital account has also improved. About US$ 295 million of official macrofinancial assistance (IMF, World Bank's economic recovery loan and Japan Exim Bank) have been disbursed since mid-1994. In addition, the NBS issued in July 1994 a US$ 250 million bond in the Samurai market. FDI increased from about US$ 100 million in 1993 to US$ 184 million in 1994, although it remains low (1,5 % of GDP). Finally, the tight management of interbank liquidity by the NBS, in combination with the perceived stability of the Slovak crown (and, in the first half of 1995, the expectation of a revaluation against the Czech crown), has led to some short-term capital inflows.

These favourable trends in both the current and the capital account have been translated into a substantial increase in reserves. Official foreign exchange reserves have risen from US$ 415 million at end-1993 to US$ 2,2 billion in April 1995, or about three months of imports.

In April 1995, the US rating agency Standard & Poor's upgraded Slovakia's rating from BB- to BB+, or just one notch below the investment grade category. Moody's is also considering an upgrading of its rating to Slovakia. All this should have a positive impact on the country's access to the international capital markets.

Following a 10 % devaluation in July 1993, the exchange rate of the Slovak crown has been kept stable against a basket of Western currencies. In July 1994, the number of currencies in the basket was reduced from five to two (the German mark and the US dollar). In December 1993, the Slovak crown and the Czech crown were, respectively, devalued by 5 % and revalued by 3 % within the clearing system. However, the 3 % revaluation of the Czech crown was reversed in March 1994, and in mid-May, in response to growing speculation on a revaluation of the Slovak crown within the clearing system, the devaluation of the Slovak currency was reduced from 5 % to 1 %.

3. Structural reforms

The Slovakian authorities announced in spring 1994 a plan to accelerate privatization based on a greater reliance on voucher privatization. As of end-August 1994, about Sk 65 billion worth of equity had been slated for inclusion in the second wave of voucher privatization, and between September and November 1994 about 3,5 million citizens (out of a total of 3,8 million eligible citizens) had registered to buy vouchers.

The political stalemate following the 30 September/1 October general election, and the redefinition of the privatization strategy by the new government resulted in a significant delay of the privatization process The newly elected parliament invalidated some direct-sale privatization contracts concluded by the interim government after 6 September 1994, and the voucher scheme has been significantly scaled down and delayed. The emphasis is expected to be switched back from voucher to standard methods. Priority will be given to direct sales to strategic investors, including sales through instalments to managers and employees.

In the area of banking sector reform, new, stricter regulations on the classification and provisioning of bad loans came into force in March 1995. The Slovak Parliament is expected to pass by mid-1995 amendments to the tax laws granting full tax deductibility for bad-loan provisions made by banks during 1995 to 1997. Banks wishing to temporarily benefit from the full tax deductibility of provisions will have to commit themselves to a restructuring programme approved by the NBS, will not be permitted to distribute dividends for several years and will have to make substantial efforts to reduce or keep in check operational costs (including wages). It is also hoped that the ongoing strengthening of the Slovak economy will have some positive effect on the problem of non-performing loans.

The authorities are studying the possible introduction of a deposit insurance scheme, and are preparing changes in the NBS and commercial bank acts aimed at strengthening the supervision and intervention powers of the central bank.

Following abuses and irregularities by certain investment privatization funds (IPFs) and investment companies, the Ministry of Finance has restricted the operations of several of them and is planning to tighten their regulation. The legal amendments being prepared would aim at increasing the transparency and control of their activities, and at better protecting the interests of the shareholders of the IPFs. There is, however, some concern that the amendments may also limit the IPFs' role in corporate governance.

The Ministry of Economy has placed under liquidation 168 State-owned enterprises that are under its jurisdiction, although the process has been completed for only 12 of them. The appointed State liquidators are having difficulty in selling their assets, largely due to the excess supply in the real estate market. Also, the authorities are preparing amendments to the bankruptcy and conciliation law aimed at some existing deficiencies and permitting a more speedy resolution of cases.

The government is committed to making the crown fully convertible for current account purposes by 1 January 1996. Consistent with this, the NBS raised the foreign exchange travel allowance by two thirds (to the equivalent of US$ 500 per year per person) as of 1 January 1995. The Czech-Slovak clearing system is expected to be terminated in the second half of 1995. In May 1995, the Czech Government decided to formally request its elimination.

In addition to their plans to introduce full current account convertibility by 1 January 1996, the authorities are envisaging the liberalization of several types of capital outflows and inflows, and in particular outward direct investment, which is still subject to authorization by the NBS. The NBS is finalizing a new Foreign Exchange Act that will provide the appropriate regulatory framework for both the introduction of full current account convertibility and the partial liberalization of capital movements.

Despite the clear improvement of the current account and balance of payments, the Slovak authorities announced in early 1995 their intention to maintain until end-1996 the 10 % import surcharge introduced in March 1994. The current government plan implies the reduction to 7,5 % of the surcharge by end-1995 and its gradual elimination in the course of 1996 provided that the balance of payments position remains satisfactory. In justifying their decision, the Slovak authorities argue that the expected recovery of domestic demand, the planned introduction of full current account convertibility and the liberalization of some capital outflows could negatively affect the balance of payments in 1995 and 1996.

Most prices have been liberalized. The share of items that still have regulated prices represents only about 5 % of total turnover. These items include energy (electricity, gas and heating, petrol), water, pharmaceutical products, rents, telephone and telegraph and public transportation. Prices for electricity (particularly those paid by households), gas and heating are significantly below their economic cost recovery levels. Electricity and gas tariffs have practically not been adjusted since 1991. The authorities are expected to present by end-June 1995 a plan to gradually bring in the coming years those prices close to their economic cost recovery levels.

4. Implementation of macrofinancial assistance

The programme agreed with the IMF for 1994 to 1995 remains on track. Although the implementation of some of the structural reform conditions has been delayed, all the macroeconomic targets and quantitative performance criteria have until now been met. Given the improvement in the balance of payments, however, the Slovak Government has announced that it will not draw, for the time being, on the remaining tranches of the standby credit.

In the first half of 1995, the Commission held preliminary discussions with the Slovak authorities on the economic policy conditions to be related to the implementation of the EU macrofinancial assistance. In this context, the Commission emphasized that, in view of the favourable developments in the external account, the situation was propitious to start implementing a phasing-out of the 10 % import surcharge without further delay. The Commission also insisted on the importance of continued progress in th